The monthly S&P500 Emini futures candlestick chart has not had a pullback in 14 months. This has...
Do Just One Thing Exceptionally Well
02/27/2012 2:45 pm EST
By mastering just one set-up, David Paul, PhD explains that he has achieved positive expectancy, a condition where win rate combines with favorable risk/reward to create consistent profits.
Dr. David Paul is my guest. Dr. Paul, walk me through your trading strategy. How you set up, how you enter a trade, how you manage the risk, and how you time your exit.
I primarily trade the London market, and I will typically be looking at the euro against the dollar, the pound against the dollar, or maybe the DAX in the morning, which is a German market, but on the currency markets, I’d be looking for some evidence of a trend.
I’ll then be looking at the overnight range. This is the range that the market made in the East. I’ll do my best to try and work out the high of the overnight range and the low of the overnight range, and the London day starts about 7:30 a.m. London time. If the trend is up, I’ll be looking for the market to come back a little bit and probably go below the low of the overnight range.
That’s where all the stops will be, and that’s where all the liquidity is. That will allow the people and institutional traders to get filled relatively easily down in there.
If I’m correct, the market will move up from there. If I’m incorrect, I just lose a little bit—about 30 points on the euro at the very most. If I’m correct, I’ve got the full daily range of 120 or 130 points in front of me, so immediately, if my prognosis is correct, I have a risk/reward ratio of about three to one.
See related: Make Sure Risk/Reward Is on Your Side
On those 30 points of a loss, if the market in fact changes trend, I would be willing to risk about half a percent of my speculative capital. I would be risking half a percent of my speculative capital to make one and a half or maybe two percent if the trade works for me.
I use the concept of Fibonacci to project targets, and Fibonacci is either sent down by God, or there are lots and lots of people using the same stuff, because the market will go to those levels over and over again.
Some mornings, you don’t get a trade. For example, the market just sits and goes sideways, which is not uncommon on a Friday morning in London as the market waits for major news announcements out of the US, which tend to come in on a Friday afternoon at half past eight eastern time.
I would be looking to have some evidence of a trend. I would want to fade the short-term trend down and the direction of a long-term trend up. I would want to try and put my entries where I know millions and millions of small traders will have put their stops.
I want to try and engineer a hit rate of 50% or 60%, but very importantly, I want to engineer a risk/reward ratio of at least three to one. This means that when I’m right I’m going to make 18 units, and when I’m wrong I lose four units, which means I make one dollar forty for every dollar risk.
If you’ve ever read David Copperfield, you will realize that there was a gentleman David Copperfield called Mr. Micawber, and he said "Annual income 20 schillings, annual expenditure 21 schillings, result: misery. Annual income 20 schillings, annual expenditure 19 schillings, result: happiness."
Happiness in trading comes from a mixture of a reasonable hit rate and a high risk/reward ratio, which gives your system an overall expectancy.
The word "expectancy" was made quite famous by an American trading psychologist called Van Tharp, and he’s written some very good books on it.
So that’s what I do, and I’ve been doing it every morning. It’s quite a boring process. We do the same thing over and over again.
But practice makes perfect.
We only need one set-up, yes, and you really need to own that set-up and spend enough screen time until you’ve made that set-up your own. Many of the best traders I know just do the one simple thing exceptionally well.
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