66.93$263.02$249.31−$104.53
169
Trades by industry groupUndefinedComputer soft and svcs,business software and servicesDrugs, biotechnologyInternet, software and servicesElectronics, semibroadComputer hard, peripheralsDrugs, manufacturers, otherHealth svcs, specializedComputer hard, diversifiedsystemsWholesale, computersInternet, service providersComputer soft and svcs,application softwareMaterials and const,heavy constructionTobacco, cigarettesElect, semiequip and mateElect, semimemory chipsElect, semispecializedInternet information providersElect, semiintegrated cirTotals
Trades
Gains
Losses
Profit
Best Trade
Worst Trade
% Gainers
Avg. Trade
24174
15114
960
$7,429.58$44,958.92
$8,109.19$7,067.54
−$14,350.04−$1,853.71
62.5%65.5%
$309.57$258.38
329164321
111042210
218122111
−$836.47$374.78−$77.85$2,832.73$7,890.61$198.60−$1,726.99
$584.27$2,001.63$0.00$1,922.55$5,497.73$549.06$0.00
−$741.80−$688.87−$77.85−$886.26−$2,203.47−$350.46−$1,726.99
33.3%37.9%0.0%66.7%51.2%50.0%0.0%
−$278.82$12.92−$77.85$472.12$183.50$99.30−$1,726.99
11176
0181
1095
−$123.80$2,002.85$2,683.35
$0.00$2,002.85$4,058.91
−$123.80$0.00−$10,554.04
0.0%100.0%46.0%
−$123.80$2,002.85$15.25
197
98
99
$17,732.62
$6,077.18
−$2,914.28
49.7%
$90.01
3125773
3002330
0123443
$5,832.19−$14,713.38−$355.09−$4,446.92−$678.62−$975.76
$3,535.17$0.00$0.00$1,396.26$586.13$0.00
$0.00−$14,713.38−$290.42−$2,756.48−$990.10−$777.19
100.0%0.0%0.0%40.4%42.9%0.0%
$1,944.06−$14,713.38−$177.54−$78.02−$96.95−$325.25
731
377
354
$68,001.35
$8,109.19
−$14,713.38
51.6%
$93.03
TABLE 9.3 Trade Analysis for New Trader(From April 1, 2000, to April 30, 2000)
170
Trades
Gains
Losses
Profit
Best Trade
Worst Trade
% Gainers
Avg. Trade
Long vs. shortLongShort
8966
3835
5131
−$20,683.16$22,018.68
$669.37$8,423.13
−$7,362.81−$13,427.40
42.7%53.0%
−$232.40$333.62
Shares tradedLess than 200 shares201–500 shares501–1000 sharesMore than 1000 shares
713972
36550
47422
$457.87$8,352.40$9,005.69−$16,480.44
$485.59$8,423.13$8,105.41$0.00
−$239.41−$7,362.81−$3,884.69−$13,427.40
42.9%46.8%71.4%0.0%
$65.41$60.09$1,286.53−$8,240.22
Share price$1–$10$25.01–$50$50.01–$100$100.01 and up
178463
114625
063838
$7,906.93−$613.36$10,234.47−$16,192.52
$7,906.93$99.78$8,423.13$1,116.32
$0.00−$231.48−$13,427.40−$7,362.81
100.0%14.3%54.8%39.7%
$7,906.93−$87.62$121.84−$257.02
Term of tradeDay tradeShort term (1–3 days)Midterm (4–10 days)
142103
6751
7552
−$4,780.96$6,764.36−$647.88
$1,637.28$8,423.13$2,612.41
−$1,988.11−$13,427.40−$3,053.04
47.2%50.0%33.3%
−$33.67$676.44−$215.96
71481263213
312382126
402544207
−$5,883.70−$103.12$1,000.86−$1,855.68$441.87$1,618.81$6,116.48
$1,116.32$1,637.28$1,118.28$166.48$917.20$1,387.76$8,423.13
−$1,954.57−$893.94−$425.63−$1,988.11−$429.03$0.00−$13,427.40
43.7%47.9%66.7%33.3%33.3%100.0%46.2%
−$82.87−$2.15$83.41−$309.28$147.29$809.41$470.50
67184
3191
3693
$300.27$418.14−$709.68
$7,800.26$669.37$284.47
−$3,884.69−$455.65−$362.24
46.3%50.0%25.0%
$4.48$23.23−$177.42
Minutes in day trade0–5 minutes5–15 minutes16–30 minutes31–60 minutes61–120 minutesMore than 120 minutesNot a day tradeTrades by Industry groupElect, semiintegrated cirElect, semimemory chipsComputer soft and svcs,business software and services
171
Trades
Gains
Losses
Profit
Best Trade
Worst Trade
% Gainers
Avg. Trade
UndefinedInternet, software and svcsComputer hard, periphInternet info providersElect, diversifiedDrugs, biotechnologyTelecom, communicationEquipmentElect, semispecialized
411163413
0563202
46100211
−$1,281.52−$790.08−$3,715.07$783.86$301.06−$550.84$91.68
$0.00$544.17$574.58$328.17$352.65$0.00$356.08
−$549.37−$794.93−$3,053.04$0.00−$56.96−$550.84−$526.73
0.0%45.5%37.5%100.0%50.0%0.0%66.7%
−$320.38−$71.83−$232.19$261.29$75.27−$550.84$30.56
24
14
10
$6,487.70
$8,423.13
−$13,427.40
58.3%
$270.32
Totals
155
73
82
$1,335.52
$8,423.13
−$13,427.40
47.1%
$8.62
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RULES OF THE TRADE
THE JOURNALAll the traders discussed above are real, and so are the results. Allhave taken important steps: They’ve captured and evaluated dataabout their trading patterns. Their work, however, is not finished.As I stated in Chapter 1, traders should maintain a daily journal.The journal allows traders to talk to themselves in an honest, private way. The best method I have found is to buy a bound, blankjournal and create columns—which allows for the date, securityand size traded, strategy, price, and comment area to describe youremotional state each day. Like working out, some days you areheavy and tired, while other days you just want to tear it up. Whatmay have motivated these emotions is useful to journal, especiallyin the beginning. Emotional and psychological forces and howthey work for or against you can provide tremendous insight. Thiswill help you decide which emotions to trust and which to fade.Sound too detailed? Too programmed? Too boring? That isup to you, but I can tell you this: It cannot hurt you! It only hasupside, and I like scenarios with limited downside and substantial upside; they usually form great trades.Use these numbers to determine how efficient you are. Forexample, if you cancel a large percentage of your orders, it maydenote indecision or lack of conviction on your part. Lookingback on how the trades worked out may indicate that you shouldtrust your instincts and convictions. Because the software available lets you see every trade, cancellation, and order, even ifunexecuted, you will know exactly when you placed the orderwhen you backtrack to your analysis.If your conviction is weak, that really means your confidenceis weak in the trade, and you may need help improving your skillsin reading the Level II and Time & Sales windows or other toolsyou utilize to formulate trading ideas. Studying figures like theseand reviewing them with your mentor will help you.
FREQUENT REVIEWSThis rule, Update and review weekly, is perhaps one of the mostneglected practices of traders. Having a trade plan is your map;looking at it weekly is the only way to steer a true course to your
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objectives. I recommend that you do this each week, perhaps onSaturday or Sunday. You should be able to obtain a profit-andloss statement from your firm, or better yet download it fromtheir Web site, since all the trades are matched, and, therefore,they should be databased. If your firm does not have a readablefile that you can import into a good database like MicrosoftAccess, then find one that does. This information is too valuableto ignore. The P&L report isolates each round-turn trade andincludes a list of open positions as well. This should be doneafter all your trades are booked for the week. You then can printit out and use it to make sure you are following your plan.
THE BUDDY SYSTEMIf you don’t have a significant other in your life, you can stillbenefit from partnering with another person. A practice thatworks for many is the same principle that works for physical fitness: the buddy system. If you have a weightlifting partner, forinstance, and you agree to meet each morning at 5:30 a.m. at thegym, you will feel what most reasonable people feel—what wecall imposed discipline. This simply means that your obligationto show is imposed on you by the other party and your respectfor the other party. Not showing after your buddy drags himselfout of bed at 5:00 a.m. to get there on time is not going to be wellreceived, believe me! The same theory works well regarding yourtrading plan. Have your partner review your plan while youreview his or hers. Any breach of discipline brings accountability to each party and will be a good source of support. I have seenthis relationship work well with husbands and wives, brothersand sisters, friends, and so on.
SPOUSAL SUPPORTI know people who get their spouses involved, not always totrade but to support the trader of the house with detailed analysis like this. The patterns that can be seen from another perspective can be invaluable to you. Additionally, what a great way toget your significant other involved with not just your trading but
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your life. Remember, trading is one of your passions, whichmeans you will spend a good bit of time engaging and researching the market. Wouldn’t it make sense to include the mostimportant teammate you will ever have?I work with my wife, Tracy, and I have done so since almostthe beginning of my career. She has worked in my office for thepast 10 years, and she has a huge impact on my success. I can tellyou that having your spouse involved with every aspect of yourlife is very gratifying and rewarding—not just financially but alsoemotionally. If you are reading this and feeling nauseated, perhapsyou have some bigger issues to deal with before you try to conquerthe mind game of trading. Of course, this close interaction withyour spouse or significant other is not for everyone. I know manygreat traders who do not share this aspect of their lives, but formany others the experience is quite rewarding. As a caution, I willtell you never to hide your trading results from your spouse. Oneday I had a crushing day in the market, and I neglected to share itwith my wife even after she asked how my day was. I thought Icould trade my bad day away, and she would never need to know.That was a huge mistake because not only did that put increasedpressure on me the next day but I felt even worse when my trading pattern for the week worsened. Finally, I selfishly had tounload my poisonous lie that was killing my trading to just get myattitude back. My wife was very obliging to the losses because shehas confidence in me but very upset for the lie through omission.She threw a few insulting blows my way and reminded me that wewere a team. Of course, I write down my true feelings here, butduring the spat I instead employed my foolish wit and replied toher, “It is these problematic qualities I possess that kept me fromgetting a better wife!” You can guess where that got me. So here isanother rule worth following: Don’t lie to your spouse or significant other. With all fun aside, your spouse can also be a great mentor, coach, or team player.Taking the patience and time to evaluate your progresstoward your goals and how well you are adhering to the rulesyou set for yourself is often seen as a mundane task that newtraders are reluctant to engage in. But I can tell you that I stillenjoy running my trade analysis and studying my patterns aswell as writing in my journal. The effort pays many dividends,both financial and emotional, and those traders who embrace theprocess will not regret it.
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10
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RULES FORTECHNOLOGY AND THEINTERNETKnow your technology.The more bandwidth, the better.The cleaner the connection to the Internet,the better.Your system is no stronger than its weakestlink.Spending too much time on hardware,software, or Internet connectivity tends tobe counterproductive to trading.Never walk away from a live order.Always know your positions and the fundsin your account.175
Copyright 2001 The McGraw-Hill Companies. Click Here for Terms of Use.
Use redundant systems to access your brokerage firm.Ping before you trade.
176
A
s a rule, serious traders concentrate on trading, not onknowing how a computer works or how to write brilliantprograms that select stocks complete with entry and exitpoints. For the record, there are no magic programs that can doyour trading or thinking for you. Technology is a tool that aids theelectronic trader; it does not replace him or her. This explainswhy the market making systems still exist today and are biggerthan ever. Human beings still drive the market, and trading takesguts as much as brains. It is as much intuitive as cerebral.Nevertheless, whether you are implementing a programtrading system as an institutional trader or connecting to anEDAT brokerage firm, technology is taking a larger and largerrole in the world of trading. As an individual trader or investor,one of your most important considerations is establishing a solidInternet backbone, whether you are an online trader or an EDATtrader. Therefore, my rule Know your technology is criticalbecause of this one important point: Technology providers willnot always tell the truth. Strong statement? Absolutely. True?Absolutely. Electronic traders don’t have the luxury of excuses,so don’t accept any from your providers.Internet service providers (ISPs), telephone companies (telcos), and even hardware providers make up the subcomponentsthat complete the loop that successfully connects you to the market. Many factors can go wrong within these many links, and Ihave found that if you cannot understand the language in thetechnology and Internet world, many providers will take advantage of your ignorance. When technology fails—and it will sincethere are potholes in the information superhighway—you mustbe able to diagnose the problem yourself or at least understandthe excuses that will be given to you about why things are notworking out. In the defense of technology providers, technologyhas grown so fast that the management of human resources is avery difficult challenge for providers. The ability to acquire,177
178
RULES OF THE TRADE
train, and retain competent people in the technology field isactually a bigger challenge than creating the technology itself.Therefore, your ability to take control to understand the systemsthat you will employ will allow you to gain the respect requiredfrom the technical support personnel of these providers. Notonly will you find much faster solutions to your problems butyou will also realize the benefits of knowing the technology,which will contribute to your trading performance. Additionally,by understanding technology better, you can help yourself toestablish opinions of various sectors and companies, and that isvery useful to the trader and investor as well.Remember, technology for the electronic trader is considered“mission-critical” systems and data. Without a high-quality system, delays in data handling and downtime will cost you. Thiscould be considered a technology impact cost (TIC), meaning thatcost in trading performance due to kinks or flaws in the system. Alow-bandwidth connection that slows down your access to critical information, especially price quotes in heavily traded stocks,will prove far more expensive in your trading performance thanpaying for a high-quality system in the first place. “Pennywiseand pound foolish” comes to mind when we see new participantsignore this point by taking the low-cost alternative.A good basis for determining your bandwidth and hardwareneeds is to use the market itself in terms of volume. Rememberthat volume often spikes just when you need price quotations thevery most—when the market is making major moves up or down.These are instances when you most need timely quotes. Activemarkets create opportunities for active traders, and active markets require vibrant connections to the Internet.The Internet is an incredibly complex system, with information flowing from one end of the system to the other—withthousands upon thousands of computer systems linked together.The larger the bandwidth capacity between one computer andanother or between a computer and an information routingdevice, the faster more information can be conveyed. As marketactivity swells at critical times of trading, the bandwidth capacity must grow accordingly.As a trader, you rely on the ability to get inbound information and send outbound messages. You must know the inside bidand ask at a very minimum. To execute an order to hit the bid or
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179
lift an offer, you must be able to send your order to your brokeror place it directly in the market through an ECN or other EDATsystem. Knowing how much bandwidth and computer capacityyou will need to trade is critical. Therefore, the rule The morebandwidth, the better. As a general rule, you should always optfor the maximum bandwidth available. The more bandwidth youbuy, the higher the cost. There are three basic types of tradingsystems, and each has its own bandwidth requirement, rangingfrom modest to extensive. If you are only going to be using a system requiring only the modest bandwidth requirement, that is allyou should buy. There is no need for you to invest in 2-inchdiameter pipe when you need only 3⁄4-inch pipe. This would bethe case for the online investor who makes occasional trades butdoes not rely on real-time information.The three types of trading platforms are the Web-based,hybrid, and EDAT. In each case you get your trading softwarefrom a broker-dealer. No matter how you place a trade, it eventually goes through a brokerage firm that has made arrangements toclear your trades. Clearing simply means the trade is matchedwith the other side, referred to as the contra. Buys must bematched with sells and vice versa. Also keep in mind that theprice quotations you receive can be live (real time) or delayed. Ifthey are live, fees must be paid to the exchanges. You pay theexchange fees directly as part of the software fee or indirectly viathe commissions you pay your broker.The Web-based trading system is the most common. It iswhat is generally known as online trading. The trader accessesthe trading platform via his or her Internet browser. The key elements of the system are the ISP, the line from the Internet to thecomputer, the modem, and the computer. This type of systemoperates satisfactorily with a regular telephone line, a 56Kmodem, and almost any computer manufactured in the last fewyears. The reason is that only modest bandwidth is required.As the systems become more complex, more bandwidth andcomputer power are required. The more complex the system, themore sophisticated the trading becomes. The online trader onlyobserves the research and information that is made available tohim or her on the brokerage firm’s Web site or other sites he orshe visits. This type of trader cannot create his or her own charts,run technical studies on them, or conduct proactive analysis in
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RULES OF THE TRADE
real time. On these online trading sites, the depth of the pricequotation information is limited. For example, on most systemsyou can request only one quote at a time, and you see only theinside market. These are the reasons the bandwidth requirementis low.The hybrid trading platform offers the basic features of theonline system plus some of the functionality of EDAT trading.The software now resides on the trader’s computer, rather thanthe Internet. On this system, you may have access to a singleLevel II window and a more advanced charting package. It mightinclude direct access to one or more of the ECNs, as well as allowyou to place orders by e-mailing your broker’s order desk. Yourbandwidth requirement is higher because you are receiving a lotmore quotes, and high-quality real-time data and quotes can bebandwidth hogs. Also, the software resides on your computer, sothe hardware requirements increase.The most advanced system for the individual trader is theEDAT platform. You can create as many Level II windows as yourcomputer system can handle. Very active traders usually havefour or more open to track the stocks they expect to trade thatday. Because an EDAT platform has all the bells and whistles, itrequires the most bandwidth. It must draw huge quantities ofdata to populate multiple market maker windows, time and salesinformation, charts, and numerous decision support windows.This system requires more attention and is irreplaceable to daytraders and active traders.In all cases, a very reliable Internet connection is a minimum requirement. Since the need of the EDAT trader is the mostcomplex, let’s study the schematic in Figure 10.1 to see how yourcomputer connects to the Internet and what makes up the backbone. You have several options to hook up your computer to theWorld Wide Web:• POTS: Plain old telephone system—that is, copper wiretransmitting at about 56K per second at a cost of about$15 per month. This can work fine for online trading,particularly if the line is clean, meaning that it has notbeen split and there is little or no interference. It maynot be enough for the EDAT trader. But if you have a current version of Microsoft Windows, you can use its
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FIGURE 10.1 Connecting to the Internet
multilink feature to bind two or more modems or POTStogether and get increased capacity. This is oftenreferred to as a shotgun modem.• ISDN: Integrated services digital network. This is anentirely digital signal that runs through existing telephone lines and jacks. Being digital, there is no need fora modem to convert the regular analog telephone signalto a digital format to be used by a computer. This speedsup the process and increases the bandwidth from 56kilobits to 2.0 megabits per second. The cost varies bygeographic location, but it is usually around $500 forinstallation and $150 per month to lease the line.• DSL: Digital subscriber line. This allows you to use yourregular telephone line for digital data transmission without interrupting your regular analog telephone calls. Thespeed of digital transmission determines your monthlycost. For 256K per second, it might run $35 to $40 permonth. If you boosted it up to 7.0 megabytes per second,it could run considerably more. This alternative is veryfavorable if you can qualify for it since its cost per connection speed is about as low as it gets at the time of this
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RULES OF THE TRADE
writing. DSL is “distance sensitive” in that it uses oldcopper technology already in the ground. There is a distance requirement from your access point in your areathat needs to be evaluated. Your local phone companycan test your line with one simple phone call.• Cable: This is fast becoming a popular selection, asmore and more cable companies are forming relationships with telephone companies in order to provide bothservices. You get your Internet access along with yourcable TV signal. A cable modem can provide 10megabytes per second of bandwidth or more and istherefore a very favorable system.• Satellite: This is the choice of traders in remote locations that do not have access to any of the above-listedadvance systems. A digital satellite dish receives thedata, and a regular modem converts them to a digital format for use by your computer. This means there may besome lag time when sending and receiving data. Youalso must be aware that some weather conditions, likeheavy cloud cover or snow, can disrupt transmission.But if you live in a remote location, a South Seas island,or on top of a mountain, it may be the best and onlychoice.• T-1: This is the choice of the most serious of traders,where cost is not an issue. This is the type of system youwill find on trading floors and in institutional tradingfirms and places where serious full-time traders trade. Itis a frame relay circuit providing a full trunk of 23phone lines with a point-to-point dedicated connectionto the ISP. This system is not required to use an EDATsystem, but is more associated where multiple users arerequired. Investment clubs that share office space are anexample of those people who may consider a T-1 connection.I have not mentioned the possibility of a wireless connection. In time, we feel it will become a contender. At the moment,it has not shown the reliability to provide the connectivity youneed to trade nor the speed. Nevertheless, there are some wire-
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183
less devices for the online trader that might be considered, buttest them first before using one in a live trading situation.Once you have decided what type of connection to go with,you must choose an Internet service provider (ISP). There aretwo kinds. One is directly connected to the Internet and the otheris indirectly connected. This means the latter must access theInternet via one of the former. As a rule, The cleaner the connection to the Internet, the better. You can find out if the ISP you areconsidering is directly connected to the Internet by asking one ofits representatives.But this is only one consideration. More important is thenumber of lines per subscriber. The ISPs do not expect all theirsubscribers to be connected at one time. Therefore, they havefewer lines than subscribers. The ratio is important. Look for aratio of 1 to 5 or less. You will find this out by asking them orreading their Web site, since ISPs are required by law to publishthis information.Also ask if there is an “idle” policy. Some ISPs will drop subscribers from the system if they have not accessed the system fora period of time once they are connected. All the ISPs are tryingto do is free up lines for other subscribers if one subscriber hasleft his or her computer hooked up and has been distracted byanother activity. The problem to you as a trader is that if you aremonitoring price quotes and are intently watching a trade you arein but have not accessed the system by sending a signal, the ISPsmay interpret this lack of activity as idle and kick you off the system. All of a sudden, you are disconnected. This is a problem.Many cases exist in which a trader could not immediately logback on, and we do not need to explain how this can cause problems for the market participant. You need to know the idle policyof your ISP before opening an account. Some software will periodically send a signal to your ISP while you are connected to prevent this from happening. Many national providers have thispolicy; therefore, we have found that local providers are often ag