Kane Trading - Education for Serious Traders

					May 23, 2004 Commentary (weekend edition)- Today I'm going to do one of my somewhat rare commentaries with no charts. Wait, though, don't leave just yet. I am not planning on ranting and raving about rip-off websites, or people who don't cite me when they steal my material. No, today I'm going to discuss some topics that have been coming up in e-mails, and some other interesting things. Even if you are a 'pure chartist', if you are interested at all in the Kane Trading methodologies, this will be of interest to you. Before I begin, let me quickly mention one area of business. Recall how I was worried about my grain plays? They started out just too 'perfect'? Well, shortly after that they began to roll over. They have not hit my stops yet (which I was fairly lenient with when I chose them, as I expected some whipping around), although the corn is just a whisker away. I don't like the way the corn looks, rolling down and closing just above my stop. It leaves it in position for the stop to get exceeded on a gap down opening. My gut feel was to close the play, but I also wanted to give it room and let the stop do its job. This was a tough call for me, as the look of vulnerability it has here is unmistakable to me. I chose to leave the play open, but I'm not going to be surprised if my 'theoretical risk' is exceeded. I always call it 'theoretical risk' because, with the exception of FX trading (excluding weekends), or so they 'guarantee', the stop can always be exceeded on a gap, giving me a larger loss than I expected based on my stop. In general, I tend to use a wider stop and have more tolerance in grain plays than in stock or mini plays. I will let this play out as it will, but it looks a lot less 'perfect' than when it started out. The wheat doesn't look quite as bad as the corn. We'll see. It will do what it will do from here, and that's trading. Let's move on to some topics for the day. I'll start out with some comments with regard to trailing stops and scaled exits. I have been getting a lot of feedback and interaction lately on this topic, perhaps because I have made it a real focus recently. I guess it's paying off, in the sense that many people are at least starting to experiment with some of the concepts. That's all I ask. I never tell anyone to trade any certain way or use any certain techniques. I suggest, sometimes somewhat firmly, that they experiment with various techniques (on paper) so that they can make an informed decision if anything they are experimenting with may have any merit for their unique 'Trading Plan'. This suggestion to experiment with various techniques has frequently been resisted with great vigor by many traders. Hence, I have been quite surprised lately that many are at least testing out some concepts to see if they can be of any use to them. Let me get to some ideas and thoughts, then, on trailing stops. Most of the traders I encounter use 'profit targets'. You all know how I feel about 'profit targets'. I don't use them. That makes me the real 'odd man out'. Without repeating what I have discussed at length already, I simply find I do much better with my trailing stops/scaled exits techniques. When I use 'profit targets' I eliminate all chances for 'home runs' by the very nature of the 'profit target' strategy. This just doesn't work for me, as I have said many times. I have tried to teach the concepts I use to many people, and I have laid it all out in great detail, in my book Kane Trading on: Trailing Stops. It has been a hard concept for many to grasp, as they cling to their pre-conceived notions about 'profit targets'. In fact, if I had the time I'd write another free article entitled 'The Myth of Profit Targets'. I have pondered why I think the idea of letting a play run is so hard for so many people. The best conclusion I can come to stems from an inborn aspect of human nature. It seems to me that most people are a lot less bothered by missing some potential profit than they are bothered by giving back something they already have. Here's a simple example. Say an ES mini trade has moved 5 points in the trader's favor. The trader can take the 5 points now, or say trail a stop 2 points below the market. (Note that this is an example, with made up numbers. I'm not implying that these numbers are actual numbers I might use for trading.) The idea is that the market may run and the trader might get a much larger profit. Now the mini turns down, the 2 point trail then kicks in and stops the trader out for a 3 point gain. All the trader seems to notice is that he or she had 5 points, and has to settle for 3 now. The next ten trades let's say go to 5 points profit, and then continue on to 10 or 15 points (again, not necessarily realistic ES behavior, but I'm trying to make a point). The trader happily caps the trades at 5 points profit, and never gives a thought to the missed points. I can hear it now, as I have so many times before: "The heck with the points I missed, no way am I giving back those 2 points. I had 5, and I'm happy with 5. I can't handle having had 5, and then only keeping 3." I don't understand that one bit, but I 100% accept that it is the way most traders that I have worked with feel. I simply didn't ever have feelings like that, so I was easily able to work on my current management plan. I, on the other hand, was just as bothered as these traders were, but I was bothered by seeing a trade run that I was in, and having only a tiny bit of the potential profit. The point of all this is that my trailing stops techniques are 'give-back' by their very nature. I am always giving back. I just attempt to give back from the end of the run. I can't know when the run is over until I let it run and then start to go the other way. I try to let the run play out, and then start thinking about profits. This is the aspect that makes it so hard, I feel, for most traders. Giving back is excruciating, or even impossible, for many traders. They see it start to go against them, and off the trade goes. This is true for many veteran traders, too. The use of trailing stops requires a very high level of comfort with giving back. Many traders feel, for example (and again, it's a made up example, not a representation of necessarily realistic numbers), that if they gave back 2 points on every mini trade, they'd be better with the 5 points when they have it, than a bunch of 3's, and then a few runners. This is where I say: 'If you've done the research and crunched the numbers, you know what adds up to the most overall profits for you. For me, it's with the trailing stops. If it weren't, I wouldn't use them. Each trader has to decide for him or herself what nets them the most profits for their 'Trading Plan'.' I have just found no comparison with the give back strategy and the 'profit target' strategy. The former works way, way better for me. I just hate to see traders using sub-optimal strategies in their trading because better strategies are psychologically uncomfortable for them. Let's look at one more concept here. I am forever trying to tell traders to 'de-emphasize' the importance within their 'Trading Plan' of the potential trade area (PTA). Think of this as the pattern or reason for your interest in a trade at this particular time. In 'the industry' (that is, the endless array of product sellers) just about the entire focus is on the 'market call'. The newsletters, the software, the books, it's all about making or receiving better picks. I see tons of 'Our picks are 88% accurate' and 'We had 57 winning trades in a row', and on and on. If you haven't read my free article The Myth of Predicting the Market yet, please click on this link and read it now. The PTA, the so-called 'market call' as many call this, is only one aspect of a comprehensive 'Trading Plan', and for my trading it's a remarkably small part. By that I mean that it takes up a way, way smaller percentage of the total plan than I, or anyone I talk with, would expect. I have long since learned that I can only do so much with trying to get better at 'picking the spots'. I have things I look for, setups I play, and I constantly try to refine them. But it becomes a diminishing returns problem. I spend more and more time gaining less and less, all the while ignoring all the other aspects of the 'Trading Plan'. There are many more ways to improve results than focusing intensely on one single area while ignoring all the other areas. In a way, as some kind of an analogy, it's like being a farmer and say you have 10 plots of land. You plant only one, but spend every waking moment trying to maximize what you can get from that one plot. You study and work and try to squeeze a few more ears of corn out of the plot. All the while, though, you let the nine other equally good fields sit idle. They are of no interest to you. Only the one field is of any interest. If you just read more books, take more farm courses, you know you can do better. Does this approach make sense? Yet this is what I see endless numbers of traders doing. And they tell me they are doing those other things, and doing them well. And sometimes they buy all my books except Trailing Stops 'because I already have that mastered, and besides, I use profit targets'. I spend something like 90% of my 'study time' on areas away from the PTA aspect of my game plan. I have done the 'PTA thing' into the ground. I have my skill set there. What I see are other areas that could be improved upon. I'm trying to balance my 'Trading Plan'. It's like a bodybuilder who only did chest and arms (sound familiar?). That doesn't cut it in the pro ranks. Now I have to bring up those 'sparrow legs', and all the rest. Now I want the overall package. I know I've used a lot of analogies here, but I do have a solid point about the overall aspects of a balanced 'Trading Plan', and I hope that most, or all, of the readers will really take this to heart and do an unbiased evaluation of where they stand. I have made vast improvements to my game plan, in my opinion, once I realized this, and started to give up my pre-conceived notions and focus on the holistic 'Trading Plan' in its entirety. I'll wrap up with an interesting story. This is the first time that I have told this story in writing, although I have verbally told it to a few students. A student recently asked me by about my listing of the book Reminiscences of a Stock Operator by Edwin Lefevre on the short list on my recommended reading page. Did I really think it was that good to make the short list? My answer was the story you are about to read. And it really is true, as bizarre as it may seem. It just goes to show how 'different' I really am. I first read this book shortly after becoming a trader, just over six years ago. I found it so fascinating and so insightful that as soon as I finished it, I immediately started it again. The second time through I learned even more. Even though it is not specific in the sense of telling a trader exactly 'what to do', it had a sense of the aspects of being a trader that I could find nowhere else. I immediately began to read it a third time. I have been an avid reader of trading books ever since I started trading. I like to read one to two books per week, sometimes more, a habit I have kept up to this day (although I spend some of that time writing books now). I also like to read before I go to bed at night, and for a market addict like myself, I prefer trading related reading. I found that advanced technical material was a little heavy for bedtime reading, so I started to read 'Reminiscences' before retiring. Again I found that I picked up a whole lot of new things on my third time through. I decided, for fun, that I was going to read it as many times as it took until I stopped finding new ideas and concepts. The book is about three hundred pages long, so if I read ten pages each night, on average, I finish the book in a month. Well, it turns out that I am still reading it. I am still finding, or better yet understanding, new things each time through. I have now read it over seventy times. You read that correctly. That may seem crazy, and I'm sure many will think that. But if you follow my commentary, books, and website, then you must have some degree of respect for my work. And if I've read this book over seventy times, that tells you something (that Jim's a nutcase??). I must mention, though, that I also enjoy the read for the pure fun of the story, and it is a relaxing way to get ready to fall asleep, with visions of trading dancing in my mind. I figure it must help me get my mind set to think about trading problems as I sleep. This is such an interesting story about my reading of this book that I thought I would pass it on to my readers. It's a book I feel every trader should read until they get no more out of it. And if you read it and get nothing out of it right off, that should red flag you, in my opinion. The next commentary will be the mid-week edition, posted Wednesday.


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