To get a computerized system edge, you need to figure out the basic human trading weaknesses and include them in your software. Anyone can buy a trading system these days, but it will have little value unless it is unique and different from the crowd. Here's some easy-to-understand ideas I use that add in the human fears!
We’re all basically wired the same. We need to be humble and admit that we really don’t know the exact point to get in or get out of a market. That’s why scaling in and scaling out of the e-mini works so well. To think we can pick the exact top or bottom on the first try is being arrogant.
One common public method of entering the E-mini is to buy a breakout and then place a stop three points below. If the stop gets hit they are relieved to get out with a “small” loss and the story is over. But, why should it end so abruptly just because we didn’t enter within three points of the exact pivot point? First of all, buying a breakout gives much of the price buffer away. Buying a dip would start us out on a better risk footing.
Let's get back to the point about scaling in and out. When the market gets tough, the tough get going. Figure the e-mini futures market is like a roller coaster. That’s really a perfect analogy. It occurred to me in a dream. We need to have a plan to respond in any way it can maneuver. The only thing we can assume is that it will have rallies after it has declines. The e-mini rallies may not bring it back to the original place (a bear market) but price will usually come back most of the way.
Let's say you buy on a sharp break. The market drops again and you average in another contract. The market then breaks again and you buy a third small lot. By this time most everyone would have been stopped out and demoralized. But because you are buying SMALL e-mini contract lots, you have staying power! You have the biggest bankroll simply by trading super small. Now the inevitable rally bounce comes.
At this point, you don’t look for a profit, but look to minimize your loss after being a bad trade. You look to get out as close to even as possible. Let the computer signal tell you when the rally has peaked and get out without hesitation. You have now faced the second to worst scenario and survived while your competition has probably taken it on the chin.
These “saved” e-mini trades all add up on the bottom line. It’s like a penny saved is a penny earned. If you are good at getting yourself out of bad situations, the good trades are all that’s left! In the previous example we have beaten three human problems. We have survived the human tendency to eliminate pain quickly when getting stopped out on the first sign of failure. We beat the fear of adding to a bad situation. Also, we avoided the greedy tendency to hold on for bigger gains when things finally go our way. (the rally) Read the previous two paragraphs over until this e-mini trading technique is clear.
Now, lets take the worst scenario. The e-mini futures market just keeps going down with no rallies. Remember that if you buy into a panic, you already have a great price buffer. Buying into two more sell-offs increases the probability of a rally. We want other traders to get stopped out so that the market can then rally. But, if the market keeps going down, we need an uncle point to spit out all the contracts.
We need an "uncle point" because human nature will again hurt us by turning us numb and paralyzed when facing a big loss. When we are facing a big loss and/or the hope to get it all back, we can sometimes do stupid things, like continue to hold on. It becomes almost suicidal, like we have nothing to lose. And this extended panic move will eventually happen, no matter where we put the stop. Probability in the e-mini futures market allows for everything, given enough time.
Part Four of Four - Next!
There is substantial risk of loss trading futures and options and may not be suitable for all types of investors. Only risk capital should be used.
