Market Advisory Features

Swing Trading: Rules and Philosophy Notes from a Swing Trader ................
The Mental Aspect of Trading Volatility Breakout Systems ...............


Time Tested Classic Trading Rules
for the Modern Trader to Live By
by Linda Bradford Raschke

This is a list of classic trading rules that was given to me while on the trading floor in 1984. A senior trader collected these rules from classic trading literature throughout the twentieth century. They obviously withstand the age-old test of time.

I'm sure most everybody knows these truisms in their hearts, but this list is nicely edited and makes a good read.

  1. Plan your trades. Trade your plan.
  2. Keep records of your trading results.
  3. Keep a positive attitude, no matter how much you lose.
  4. Don't take the market home.
  5. Continually set higher trading goals.
  6. Successful traders buy into bad news and sell into good news.
  7. Successful traders are not afraid to buy high and sell low.
  8. Successful traders have a well-scheduled planned time for studying the markets.
  9. Successful traders isolate themselves from the opinions of others.
  10. Continually strive for patience, perseverance, determination, and rational action.
  11. Limit your losses - use stops!
  12. Never cancel a stop loss order after you have placed it!
  13. Place the stop at the time you make your trade.
  14. Never get into the market because you are anxious because of waiting.
  15. Avoid getting in or out of the market too often.
  16. Losses make the trader studious - not profits. Take advantage of every loss to improve your knowledge of market action.
  17. The most difficult task in speculation is not prediction but self-control. Successful trading is difficult and frustrating. You are the most important element in the equation for success.
  18. Always discipline yourself by following a pre-determined set of rules.
  19. Remember that a bear market will give back in one month what a bull market has taken three months to build.
  20. Don't ever allow a big winning trade to turn into a loser. Stop yourself out if the market moves against you 20% from your peak profit point.
  21. You must have a program, you must know your program, and you must follow your program.
  22. Expect and accept losses gracefully. Those who brood over losses always miss the next opportunity, which more than likely will be profitable.
  23. Split your profits right down the middle and never risk more than 50% of them again in the market.
  24. The key to successful trading is knowing yourself and your stress point.
  25. The difference between winners and losers isn't so much native ability as it is discipline exercised in avoiding mistakes.
  26. In trading as in fencing there are the quick and the dead.
  27. Speech may be silver but silence is golden. Traders with the golden touch do not talk about their success.
  28. Dream big dreams and think tall. Very few people set goals too high. A man becomes what he thinks about all day long.
  29. Accept failure as a step towards victory.
  30. Have you taken a loss? Forget it quickly. Have you taken a profit? Forget it even quicker! Don't let ego and greed inhibit clear thinking and hard work.
  31. One cannot do anything about yesterday. When one door closes, another door opens. The greater opportunity always lies through the open door.
  32. The deepest secret for the trader is to subordinate his will to the will of the market. The market is truth as it reflects all forces that bear upon it. As long as he recognizes this he is safe. When he ignores this, he is lost and doomed.
  33. It's much easier to put on a trade than to take it off.
  34. If a market doesn't do what you think it should do, get out.
  35. Beware of large positions that can control your emotions. Don't be overly aggressive with the market. Treat it gently by allowing your equity to grow steadily rather than in bursts.
  36. Never add to a losing position.
  37. Beware of trying to pick tops or bottoms.
  38. You must believe in yourself and your judgement if you expect to make a living at this game.
  39. In a narrow market there is no sense in trying to anticipate what the next big movement is going to be - up or down.
  40. A loss never bothers me after I take it. I forget it overnight. But being wrong and not taking the loss - that is what does the damage to the pocket book and to the soul.
  41. Never volunteer advice and never brag of your winnings.
  42. Of all speculative blunders, there are few greater than selling what shows a profit and keeping what shows a loss.
  43. Standing aside is a position.
  44. It is better to be more interested in the market's reaction to new information than in the piece of news itself.
  45. If you don't know who you are, the markets are an expensive place to find out.
  46. In the world of money, which is a world shaped by human behavior, nobody has the foggiest notion of what will happen in the future. Mark that word - Nobody! Thus the successful trader does not base moves on what supposedly will happen but reacts instead to what does happen.
  47. Except in unusual circumstances, get in the habit of taking your profit too soon. Don't torment yourself if a trade continues winning without you. Chances are it won't continue long. If it does, console yourself by thinking of all the times when liquidating early reserved gains that you would have otherwise lost.
  48. When the ship starts to sink, don't pray - jump!
  49. Lose your opinion - not your money.
  50. Assimilate into your very bones a set of trading rules that works for you.

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Swing Trading: Rules and Philosophy
Linda Bradford Raschke

My style is based on the "Taylor Trading Technique", a short-term method for trading daily price movements that relies entirely on odds and percentages . It is a method as opposed to a system. Very few people can blindly follow a system, though many find it easier to be discretionary in a systematic way.

Because this short-term swing technique generates frequent trades, it is important to know the "correct plays," to lock in profits, and to seek the "true trend." Taking a loss is merely playing for better position. One trades strictly for probable future results, not for what the market might do.

To know the "correct play" is to know whether to buy or sell first, to exit or hold. Trades are based on "objective points," which are simply the previous day's high and low. Movement between these two points determines the "true trend."

When swing trading, adjust your expectations. The lower your expectations, the happier you will be and, ironically, the more money you will probably make! Entries are a piece of cake, but you must also trust yourself to get out of bad situations and trades. It is important to use tighter stops when trading swings and wider stops when trading trends.

This method teaches you to anticipate! Never react! Know what you are going to do before the market opens. Always have a plan--but be flexible! "See" your stop (support or resistance) before initiating a trade. Know how to trade out of trouble situations and get off the hook with the smallest possible loss.

Finally, never trade in narrow, dead markets. The swings are too small. Never chase a market. Rather than worry that you've missed a move, think instead, "Oh, boy! I've got oscillations and volatility back..."

Basic Rules for Swing Traders

But first--the rules! Because of the short-term nature of this technique, swing traders must adhere to some very basic rules, including:

  • If the trade moves in your favor, carry it overnight--the odds favor follow-through. Expect to exit the next day around the objective point. An overnight gap presents an excellent opportunity to take profits. Concentrating on only one entry or one exit per day relieves the pressure.
  • If your entry is correct, the market should move favorably almost immediately. It may come back to test and/or exceed your entry point a little, but that's OK.
  • Do not carry a losing position overnight. Exit and play for better position the next day.
  • A strong close indicates a strong opening the following day.
  • If the market doesn't perform as expected, exit on the first reaction.
  • If the market offers you a windfall of big profits, take them to the bank on the close.
  • If you are long and the market closes flat, indicating a lower opening the following day, scratch or exit the trade. Play for better position the next day.
  • It is always OK to scratch a trade!
  • Use tight stops when swing trading (wider stops when trading trend).
  • The goal always is to minimize risk and create "Freebies."
  • When in doubt--get out! You have lost your road map and your game plan!
  • Place your orders at the market.
  • When the trade isn't working, exit on the first reaction.

"Trading the Swing"

How does one anticipate entry? The following may be indicators of a buy day or a sell day:

The Count
Start searching for a buying day 2 days after a swing high or, conversely, a shorting day 2 days after a swing low. Ideally, the market will move in complete 5-day cycles. (In a strong trend, the market will move 4 days in the primary direction and only 1 in reaction. Thus, one must seek entry 1 day earlier.)
"Check Mark" on the Test
The potential entry is sought opposite, or contrary to, the previous day's close. If looking to buy (sell), one first wants the market to "test" the previous day's low (high), preferably early in the day, and then form a trading pattern that looks like a "check mark" (see examples).

This pattern sets up and establishes a "double stop point" or strong support. If entering a market with only a "single stop point" or support formed by today's low only, exit on the same day--the trade is clearly against the trend.
Close vs. Open
The close should indicate the following day's opening. When a market opens opposite what is expected or indicated by the trend, one may first look to "fade" it--but must take profits quickly. Then look to reverse!
Support (Resistance)
Is today's support (resistance) higher or lower than yesterday's?
Swing Measurements
Where is the market relative to the last swing high or low? Look for swings (up or down) of equal length, and for retracements of equal percentage.

Additional Considerations!

No matter in what time frame, always look for supply at tops and support at bottoms. Penetrations should be accompanied by volume and activity.

Expect trends, either up or down, to last for either 2 or 4 weeks.

The following conditions are fairly reliable indicators for the start of one of these trends (I personally skip the first buy or sell swing when one occurs because the move ensuing could be quite strong):

  • Narrowest range in the last 7 days
  • 3 consecutive days with small range
  • The point of a wedge
  • A breakaway gap
  • A rising ADX (14-period) above 32


Because a certain amount of confidence in any technique is required to trade it consistently, paper trading can cultivate the faith necessary to recognize and trade pattern repetition. Although the temptation to try too many different styles and patterns always exists, one must strive ultimately to trade in just one consistent manner--or at least to integrate techniques into your own unique philosophy.

System Characteristics

Certain points about trading short-term swings deserve note. Understanding the nature of short-term systems can help you recognize the psychological aspect of trading.

When consistently following a short-term system, you should expect a very high win/loss ratio. Though the objectives with this style of swing trading appear conservative, you will almost always incur "positive slippage".

In all systems, winners are skewed. Even though making steady profits, 3-4 really big trades may actually make the month. It is vitally important to always "lock in" your trades. Don't give back profits when short-term trading.

You may be astonished at just how big some winners may be from catching the swings "just right!"


I feel it is important to address this topic. Every time you make a trade, you make a decision. The more decisions you make, the more you increase your self-esteem.

You grow with each decision, yet each decision has a price--you must discard a choice, and you must commit. Conditions are always imperfect! You must allow yourself to fail. Allow for human limitations and incorrect choices. Reserve compassion for yourself and your limitations.

There is so much instantaneous information available to all market players today. It is OK to use intuition and to listen to that little voice inside your head, "Does the trade feel right?" If in doubt, get out...!

Golden Rules

Finally, I want to leave you with what I believe are two Golden Rules, applicable to all traders but, of essential importance to short-term swing traders:

  • NEVER, ever, average a loss! Sell out if you think you are wrong. Buy back when you believe you are right.
  • NEVER, NEVER, NEVER listen to anyone else's opinion! Only YOU know when your trade isn't working.

Recommended reading list:

  • The TAYLOR Trading Technique, by George Douglass Taylor, 1950
  • Trading is a Business, by Joe Ross
  • Day Trading with Short-term Price Patterns & Opening Range Breakout, by Toby Crabel
  • Forecasting Financial Markets (or Technical Analysis Explained), by Tony Plummer
  • The ABC of Stock Speculation, by A. Nelson, 1903

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Notes from a Swing Trader
Extract from a 1993 lecture
by Linda Bradford Raschke

Swing trading seeks to take advantage of a very basic price pattern that sets up and can be traded in any market. Though I refer to a two- to three-day trading cycle, principles that I teach work on an intermediate time frame - weekly charts - as well as on five-minute charts.

Whether you trade short-term, from a mechanical system, or a methodology like what I teach, there is one thing I want to impress on you: Be consistent! You can't do a Fibonacci calculation on one trade, try something else the next day, and then jump into a seasonal trade the next. It just doesn't work because trading is just a numbers game, that's all it is, trying to get a little bit of an edge in your favor.

My personal rhythm consists of buying one day and selling the next, or the day after that. I carry a lot of trades overnight. I don't take many on an intraday basis, only the trades which don't work out. The ones that don't work out become intraday trades really fast. The exception, of course, is the S&P which there is plenty of opportunity to day trade.

Money (and Risk) Management

Scale in and scale out of trades. That's one aspect of money management on which I concentrate. I'm always scaling out of trades. Put yourself in a win/win situation. Take some money off the board; take partial profits. That way you can't lose. If it then goes against you, at least you locked in something. If it goes your way, you still have bullets to play with. Don't get greedy.

Most floor traders tend to make money twenty days of the month. Then in the last two days they get blown out of the water on a big trend day during which other traders are buying breakouts and cleaning up. When swing trading, you truly don't want to fight a trend day - the market is going to tell you quickly if your play is right or wrong. And if you're wrong, don't fight it.

Always go in with a game plan. Anytime market action deviates from my road map, I'm out of there because the market is not doing what I expect it to be doing. If I don't know what it is doing, why am I in there?

Anytime that you're in a trade and you start to have questions like, "Well, what should I do now? Should I get out now? Should I take profits now? Should I stay in a little longer? Should I add to the position?" Anytime you have a question like that, you have no business being in that market. You have lost your edge because you don't have any control or game plan in that market. So, first, before you start swing trading, realize that you never want to put yourself in a position where you're going to be reacting to that market.

I find the best way to control my risk is to watch my equity curve. Every day I calculate how much money I made or lost. I don't care which positions made or lost it or how many winners or losers I had. When my equity curve starts to dip, I know something is wrong - perhaps I am stressed or getting careless.

I also believe in diversification. Something is always working. Don't get married to a position; don't get an opinion on a market. If I get an opinion on a specific market, I have to stop trading it.

Finally, when a market closes against me, the odds suggest that it will go even further against me. So I get out. I can always get back in the next day at a better price. That's my rule. I don't view it as taking a loss - I'm just playing for better position! And it works!

"Reading the Tape"

The most important points to me are the previous day's high and low. That's all I care about. Now some people like to do retracement numbers, some people like to do Fibonacci numbers. Any number is going to work because it focuses your attention on market action relative to another number. You can take any number and ask if the market is getting closer to or further away from it. That's all tape reading really is. Is the price making progress towards or away from that number?

You'll find that intraday cycle tops, cycle bottoms, intraday swings, lows, highs, are important support and resistance levels. Even on five-minute time frames, watch those lows and highs on the swings. If you're on a weekly chart watch the previous highs, watch the previous lows. What you're going to do is just focus in on the price action around that point.

It's either going to be a test, with the market finding support and forming a nice double bottom (a high-percentage trade because you can put in a really tight stop and the market should move in your favor right away), or else it's going to break through (if accompanied by volume and activity, there is no support but there probably is going to be a continuation. Perhaps 90% of my trading tends to be looking at previous lows and previous highs on daily charts.

A lot of people like to look for price divergences using oscillators, or the Elliot Wave fifth wave - which is either a failure top or a last little hook through. It's still the same concept - double top, double bottom, and tests. That's what swing trading really is: Buying retracements, finding out where the market finds support, and getting out.

You just have to define what works for yourself. There is nothing wrong with one time frame or another, or one style of trading or another. But build a road map in your head. It teaches you to anticipate, to have a plan, anticipate, watch it setup.

Overnight Positions

However, I do believe in holding contracts overnight. For those of you who trade an intraday time frame, if you have a profit in your contract coming into the end of the day, try holding it overnight. The odds are you will win. Sure, one or two times it is going to gap down against you. But who cares? You took it home with a little profit, a little cushion. But the odds are that 70% of the time, you're going to get more money holding it overnight.

How many times have you come in the morning and they're gapping that market open? And you have to sit there and wait till the dust settles, and wait until the first 40 minutes of trading is out of the way. Do you know how nice it is to be able to come in with the market called to open higher - a ball of fire - and you say, "All right, suckers, if you want to pay that much for something, fine, you can have it, on the opening, yours, sold!" And usually the price will back down some after they have finished squeezing everybody who was short, everybody who had to cover on the opening.

Setting Up "The Swing"

Here is what makes a market. You have a number of different players and time frames in these markets. You have institutions, commodity pools and funds, and all that kind of big money.

On the other side are all the locals on the floor. Half of them make their profits off one tick, just trading the market back and forth. The other half usually close their positions out by the end of the day anyway. These guys are just scalping, putting money in their pockets; there are really not that many position traders in the pits.

Because of the activities of all these different market players, a two- to three-day swing pattern sets up. The big guys can't take advantage of it and the little guys don't care; but it creates a perfect niche from which to make a living.

What happens? The big players, the commercials, know the fundamentals, which their analysts have priced into the market. They know where they have to deliver x number of barrels in x number of days - a really long-term game plan. They have really deep pockets.

Those guys are right eventually; they have deeper pockets than anybody. They can sit and buy into one decline after another. Maybe three months later the thing will turn around and they'll sit on it, and then they will start selling out, selling out, selling out.

When the big guys come in to start accumulating their line, it doesn't mean the price is going to hold there, merely that at some level they start buying. The locals standing in the pit see Merrill Lynch working an order to buy 1000. They know exactly what's going on, where the big guys are, so they'll start coming in and buying a little bit, supporting the market.

All of a sudden the price is holding. Because the price is holding, all the people that shorted it earlier are going to start taking it back. Well, the price stopped going down, so they better start taking it back, which might cause the price to lift a little bit. Then it starts to rally a little bit. It trickles up, then some people feel maybe the price is going to go up, so they start buying.

Just about now, traders looking at charts notice it going up. However, by the time an outside order gets to the pit, everybody else is buying these "breakouts" and the price is already marked up - and all of a sudden outside orders are chasing it.

And sure enough, like moths to a light, everybody has already bought? The locals bought their line, the commercials are only buying at this price down here. Who's left to buy? What happens when there is nobody left to buy? The price stops going up. It doesn't fall down immediately, but the price stops going up.

When pit traders sense that loss of acceleration, when the order flow starts to slow down, those that bought in the morning when nobody else wanted to buy, who knew that the price held there yesterday - start taking their profits. That puts a little selling pressure on the market and the guys who see weakness in the market come in and start shorting it.

There are always people buying the market and always people selling it. There is constant supply and demand. There is always support and resistance in every time frame, always someone taking profits. Every long is going to have to take a profit or loss, and every short is going to cover at some point. It's like a zero sum game! It's a two-sided market. There's always going to be longs getting trapped and shorts getting squeezed.

The Rhythm of "The Swing"

So I look for a swing low and count that as day one. Day two is going to be the second day up, and day three I'm going to sell and go short - short it and look to cover on a pullback the next day. Then I'm back to day one, looking to buy.

So my rhythm is to "buy," "exit," "sell short," "exit," "buy," "exit". You find that usually there is not enough of a case to stop and reverse. I just sell and take profits. I find that to be the highest percentage. I know that I can lock it in, put it in my pocket. I do 90% of my orders at the market; I want in or I want out, I don't dicker over a tick or two.

Higher Bottoms/Lower Tops

How does the market "test the water?" Prices decline one day and the locals cover their positions. The market finds support at some point, even if just a little. What I want to do is buy the test of that support, which the market usually gives you.

The market makes a V-bottom only a minority of the time. Most of the time it makes a W-bottom, or multiple tests, sometimes with higher and sometimes with lower bottoms. Tops are very rarely an inverted V; rarely does a market go straight up and straight down. You get a test, or at least a sideways ledge or consolidation.

Don't be too anxious; think about what you want to buy, how much, where. Have a little patience, see what the market is going to do. You can make a living just buying higher bottoms and selling lower tops.

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The Mental Aspect of Trading
by Linda Bradford Raschke

Many traders quickly come to acknowledge that despite being familiar with winning strategies, systems, and money management techniques, trading success is dependent on your psychological state of mind. If you're a trader just starting out, where do you find the initial confidence to pull the trigger? How do you deal with the down times without digging yourself deeper into the hole? If you are in a hole, how do you work your way back out? How do experienced traders push through the ceiling of profitability that caps their initial trading years and make a truly fabulous living?

Trading is a performance-oriented discipline. Stress and mental pressures can affect your ability to function and impact your bottom line. Much of what has been learned about achieving peak performance in both business and sports can be applied to trading. But before looking at some of these factors, let's first examine the ways that trading differs from other businesses.

  1. Intellect has nothing to do with your ability as a trader. Success is not a function of how smart you are or how much you have applied yourself academically. This is hard to accept in a society that puts a premium on intellect.
  2. There is no customer or client good will built up each day in your business. Customer relationships, traditionally important in American businesses, have little to do with a trader's profitability. Each day is a clean slate.
  3. The traditionally 8-5 work ethic doesn't apply in this business! A trader could sit in front of a screen all day waiting for a recognizable pattern to occur and have nothing happen. There is a temptation to take marginal trades just so a trader can feel like he's doing something. There's also the dilemma of putting in constant hours of research, having nothing to show for it, and not getting paid for the work done. Yet if a trader works too hard, he risks burn- out. And what about those months where 19 out of 20 days are profitable, but the trader gives it all back in one or two bad days? How can a trader account for his productivity in these situations?
  4. If you were to invest time, energy, and emotion into developing a business venture and backed out at the last minute, it would be considered a failure. However, you should be able to invest time and energy into researching a trading idea, and yet still be able to change your mind at the last minute. Market conditions change, and we cannot be expected to predict all the variables with foresight. Getting out of a bad trade with only a small loss should be considered a big success!

What IS the definition of a successful trader? He should feel good about himself and enjoy playing the game. You can make a few small trades a year as a hobby, generate some very modest profits, and be quite successful because you had fun. There are also aggressive traders who have had big years, but ultimately blow-out, ruin their health or lead miserable lives from all the stress they put themselves under.

Principles of Peak Performance

The first principle of peak performance is to put fun and passion first. Get the performance pressures out of your head. Forget about statistics, percentage returns, win/loss ratios, etc. Floor-traders scratch dozens of trades during the course of a day, but all that matters is whether they're up at the end of the month.

Don't think about TRYING to win the game - that goes for any sport or performance-oriented discipline. Stay involved in the process, the technique, the moment, the proverbial here and now.! A trader must concentrate on the present price action of the market. A good analogy is a professional tennis player who focuses only on the point at hand. He'll probably lose half the points he plays, but he doesn't allow himself to worry about whether or not he's down a set. He must have confidence that by concentrating on the techniques he's worked on in practice, the strengths in his game will prevail and he will be able to outlast his opponent.

The second principle of peak performance is confidence. in yourself, your methodology, and your ability to succeed. Some people are naturally born confident. Other people are able to translate success from another area in their life. Perhaps they were good in sports, music, or academics growing up. There's also the old-fashioned "hard work" way of getting confidence. Begin by researching and developing different systems or methodologies. Put in the hours of backtesting. Tweak and modify the systems so as to make them your own. Study the charts until you've memorized every significant swing high or low. Self-confidence comes from developing a methodology that YOU believe in.

Concentrate on the technical conditions. Have a clear game plan. Don't listen to CNBC, your broker, or a friend. You must do your own analysis and have confidence in your game plan to be a successful trader.

Analyze the markets when they are closed. Your job during the day is to monitor markets, execute trades and manage positions. Traders should be like fighter pilots - make quick decisions and have quick reflexes. Their plan of attack is already predetermined, yet they must be ready to abort their mission at any stage of the game.

Just as you should put winning out of your mind, so should you put losing out of your mind - quickly. A bad trade doesn't mean you've blown your day. Get rid of the problem quickly and start making the money back. It's like cheating on a diet. You can't undo the damage that's been done. However, it doesn't mean you've blown your whole diet. Get back on track and you'll do fine.

For that matter, the better you are able to eliminate emotions from your day, the better off you will be. A certain amount of detachment adds a healthy dose of objectivity.

Trading is a great business because the markets close at the end of the day (at least some of them). This gives you a zero point from which to begin the next day - a clean slate. Each day is a new day. Forget about how you did the week before. What counts is how you do today!

Sometimes what will happen during the day comes down to knowing yourself. Are you relaxed or distracted? Are you prepared or not? If you can't trade that day, don't! - and don't overanalyze the reasons why or why not. Is psychoanalyzing your childhood going to help your trading? Nonsense!

The third important ingredient for achieving peak performance is attitude. Attitude is how you deal with the inevitable adverse situations that occur in the markets. Attitude is also how you handle the daily grind, the constant 2 steps forward and 2 steps back. Every professional has gone through long flat times. Slumps are inevitable for it's impossible to stay on top of your game 100% of the time. Once you've dug yourself out of a hole, no matter how long it takes, you know that you can do it again. If you've done something once, it is a repeatable act. That knowledge is a powerful weapon and can make you a much stronger trader.

Good trades don't always work out. A good trade is one that has the probabilities in its favor, but that doesn't mean that it will always work out. People who have a background in game theory understand this well. The statistics are only meaningful when looking at a string of numbers. For example, in professional football, not every play is going to gain yardage. What percentage of games do you need to win in order to make the playoffs? It's a number much smaller than most of us are willing to accept in our own win/loss ratios!

Here is an interesting question: should you look at a trade logically or psychologically? In other words, should every trade stand on its own merits? Theoretically, yes, but in real life it doesn't always work that way. A trader is likely to manage a position differently depending on whether the previous trade was a winner or a loser.

How does one know when to take profits on a good trade? You must ask yourself first how greedy do you want to be, or, how much money do you want to make? And also, does your pattern have a "perceived profit" or objective level? Why is it that we hear successful winning traders complain far more about getting out of good trades too soon than not getting out of bad trades soon enough? There's an old expression: "Profits are like eels, they slip away."

Successful traders are very defensive of their capital. They are far more likely to exit a trade that doesn't work right away than to give it the benefit of the doubt. The best trades work right away!

OK. Realistically, every trader has made a stubborn, big losing trade. What do you do if you're really caught in a pickle? The first thing is to offer a "prayer to the Gods". This means, immediately get rid of half your position. Cut down the size. Right off the bat you are taking action instead of freezing up. You are reducing your risk, and you have shifted the psychological balance to a win-win situation. If the market turns around, you still have part of your position on. If it continues against you, your loss will be more manageable. Usually, you will find that you wished you exited the whole position on the first order, but not everyone is able to do this.

At an annual Market Technician's conference, a famous trader was speaking and someone in the audience asked him what he did when he had terrible losing trades. He replied that when his stomach began to hurt, he'd "puke them at the lows along with everyone else." The point is, everyone makes mistakes but sooner or later you're going to have to exit that nasty losing position.

"Feel good" trades help get one back in the game. It's nice to start the day with a winning scalp. It tends to give you more breathing room on the next trade. The day's psychology is shifted in your favor right away. This is also why it's so important to get rid of losing trades the day before. so you don't have to deal with them first thing in the morning. This is usually when the choice opportunity is and you want to be ready to take advantage of it.

A small profitable scalp is the easiest trade to make. The whole secret is to get in and get out of the market as quickly as possible. Enter in the direction of the market's last thrust or impulse. The shorter the period of time you are is the marketplace, the easier it is to make a winning trade. Of course, this strategy of making a small scalp is not substantial enough to make a living, but remember the object is to start the day out on the right foot.

If you are following a methodology consistently (key word), and making money, how do you make more money? You must build up the number of units traded without increasing the leverage. In other words, don't try going for the bigger trade, instead, trade more contracts. It just takes awhile to build up your account or the amount of capital under management. Proper leverage can be the key to your success and longevity in this business. Most traders who run into trouble have too big a trade on. Size influences your objectivity. Your main object should be to stay in the game.

Most people react differently when they're under pressure. They tend to be more emotional or reactive. They tense up and judgement is often impaired. Many talented athletes can't cut it because they choke when the pressure's on. You could be a brilliant analyst but a lousy trader. Consistency is far more important than brilliance. Just strive for consistency in what you do and let go of the performance expectations.

Master the Game

The last key to achieving mental mastery over the game is believing that you can actually do it. Everyone is capable of being a successful trader if they truly believe they can be. You must believe in the power of belief. If you're a recluse skeptic or self-doubter, begin by pretending to believe you can make it. Keep telling yourself that you'll make it even if it takes you five years. If a person's will is strong enough, they will always find a way.

If you admit to yourself that you truly don't have the will to win at this game, don't try to trade. It is too easy to lose too much money. Many people think that they'll enjoy trading when they really don't. It's boring at times, lonely during the day, mentally trying, with little structure or security. The markets are not a logical or fair playing ground. But there are numerous inefficiencies and patterns ready to be exploited, and there always will be.

( back )


Volatility Breakout Systems
by Linda Bradford Raschke

Breakout systems can actually be considered another form of swing trading, (which is a style of short term trading designed to capture the next immediate move). In other words, the trader is not concerned with any long term forecast or analysis, only the immediate price action.

Volatility breakout systems are based on the premise that if the market moves a certain percentage from a previous price level, the odds favor some continuation of the move. This continuation might only last one day, or go just a little bit beyond the original entry price, but this is still enough of a profit to play for. A trader must be satisfied with whatever the market is willing to give.

With a breakout system, a trade is always taken in the direction that the market is moving at the time. It is usually entered via a buy or sell stop. The bit of continuation that we are playing for is based on the principle that momentum tends to precede price. There is also another principle of price behavior that is at work to create trading opportunities. That is, the market tends to alternate between a period of equilibrium (balance between the supply and demand forces) and a state of disequilibrium. This imbalance between supply and demand causes "range expansion", (the market seeking a new level), and this is what causes us to enter a trade.

There are several ways to create short-term volatility breakout systems. I have found that different types of systems based on range expansion test out quite similarly. Therefore, whichever method you choose should be a matter for your own personal preference.

In designing a system, one can choose to place an entry stop off either the opening price or the previous day's closing price. This entry stop can be a function of the previous day's range or a percentage of the previous 2.10-day range, etc. Mechanical exits can range from using a fixed objective level to using a time function such as the next day's open or close. Most of these systems function best when a very wide stop is used.

Another way of trading the breakout mode is by using "channel breakouts" which is simply buying the highest high of the last seven days in the case of a 7-period channel or the highest high of the last 2 days in the case of a 2-period channel breakout. In the case of an inside day breakout pattern where one buys the high or sells the low of the previous bar, a 1-period channel breakout is actually being used for the trigger. The most famous long-term breakout system adapted by Richard Dennis for training the "Turtles" was the 4-week channel breakout originally designed by Richard Donchian. Other breakout systems can be based on chart patterns (i.e., Curtis Arnold's Pattern Probability System), trendline breaks, breakouts above or below a band or envelope of prices, or variations of simple range expansion functions.

Training Benefits for the Novice Trader
Derived from Trading a Volatility Breakout System:

Trading a short-term breakout system can be one of the best exercises to improve your trading.

  • First, it teaches you to do things that are hard to do - buying high or selling low in a fast moving market! For most people, this feels quite unnatural!
  • Second, it always provides a defined money management stop once a trade is entered. Not adhering to a defined money management stop is the most common cause of failure among traders.
  • Third, it teaches a trader the importance of follow-through once a trade is entered, as most breakout systems perform best when the trade is held overnight.
  • Last, it provides a great means for traders to improve their execution skills. Most volatility breakout systems are fairly active compared to a long-term trend following system. A trader can gain skill in placing orders in a diverse number of markets. Having a mechanically defined entry point is sometimes just the thing needed to overcome a trader's fear of pulling the trigger. The order is placed ahead of time and the market then automatically pulls the trader into a trade if the stop level is hit.

Even if a person prefers to ultimately enter orders using discretion, trading a mechanical volatility breakout system can still be an invaluable exercise. It should at least increase a trader's awareness of certain types of price behavior in the marketplace, especially if one is conditioned to entering on counter-trend retracement patterns. It can't but help impress upon one the power of a true trend day.

Pros and Cons of Trading a Breakout System:

Like most systems, volatility breakout systems will clean up in volatile or runaway markets but tend to thrash when conditions get choppy or volume dries up. I believe they are still among the most profitable type of system to trade, and I also feel they will continue to be profitable in the long run. They are "durable" and "robust", though they tend to deteriorate when too large of an order is placed (i.e., greater than 50 contracts). However, so that you do not get the impression that there is a Holy Grail of systems, the following considerations should be kept in mind:

Entries can be nerve-racking, especially when the market is in a runaway mode. The best breakouts won't give you retracements to enter on. You are either on board or you are not! If you conceptualize that the best breakouts turn into trend days, and are most likely to close on the high or low for the day, then it is not so difficult to enter. Usually it is best to have a buy/sell stop already resting in the marketplace.

Sometimes a market gaps open outside your initial entry level. These often turn into the best trades. They can also turn into the most aggravating whipsaws. Big gaps test out that one should still take the trade, but they will definitely add more volatility to your bottom line. If your trade gets stopped out and an new signal is given in the opposite direction, this reversing trade usually more than makes up for the first loss.

Whipsaws are a drag but they are also inevitable when trading a breakout system. Many times I have bought the highs and sold the lows. It takes a great deal of "confidence in the numbers" to trade this type of system. System testing should always be done for a minimum of 3 years, preferably 10. Be sure to then examine out of sample data to see how the system performed.

On balance, a volatility breakout system can be traded on most all markets. However, a market might be very profitable one year and yet perform mediocre at best the next. A portfolio of 10 to 12 markets seems to work well. The problem with trying to trade too many markets at once is that it can become quite difficult to keep up with the activity level if your parameters are fairly sensitive. Many times in systems development, people overlook what one person can realistically manage.

Enhancing a Basic Volatility Breakout System:

Adding filters can sometimes create further enhancements. Examples of types of filters include: indicators to determine whether or not a market is in a trending condition, seasonality, days of the week, or degree of volatility contraction already present in the market. Periods of low volatility in the market can be defined by a contraction in true range, a low ADX, or a statistical indicator such as a low historical volatility ratio or a low standard deviation.

A system then might look something like this:

  1. Initial volatility condition = true
  2. Buy or Sell on a stop based on the current bar's open, plus or minus a percentage of the previous day's range.
  3. Initial Risk management stops once a trade is entered.
  4. Exit strategy.

Types of variables which can be used in a simple range expansion breakout system:

  1. Period - is the breakout based on a function of the previous day or the previous 10-day period, for example?
  2. Range - does it use the average range for that period or the largest, smallest, or total range?
  3. Percentage - what percentage of the range is used? It is possible, for example, to use 120% of the previous 3-days' total range.
  4. Base - is the range function added to the previous day's close or the current day's open. This function may also be added to the high or low of the previous bar or a previous period such as the last 10 days.

As a general rule of thumb, the greater the percentage factor used, the greater the percentage of winning trades will be. However, the overall system may be less profitable because fewer trades are taken.

Once again, an example of an initial condition might be: Enter a trade only on a day following the narrowest range of the last 7 days. Or, take a trade only if the market has made a new 20-day high or low within the last five trading days. Whenever you add a filter to a system, be sure to compare the results to a baseline and examine the difference in activity level.


  1. Time based (2nd day's close, 1st day's opening)
  2. First profitable opening (Larry Williams)
  3. Target or objective level (1 average true range, previous day's high/low)
  4. Trailing stop (displaced moving average, parabolic, 2-day high/low)


Controllable Risk - the amount of risk which can be predetermined and defined by a money management stop.

Types of money management stops:

  1. fixed dollar amount
  2. function of average true range
  3. price level (i.e., bar high/low)

Uncontrollable Risk:

  1. Overnight exposure (close to open risk). You cannot exit a position when the market is not trading. Thus, you are subject to adverse gaps, which can be exaggerated by news or events.
  2. Slippage risk. Fast market conditions or thin, volatile markets often cause a trader to get filled at prices much worse than expected.

In general, the numbers behind most systems are very dependent upon capturing a few good trades. You can't afford to miss the one good trade that can make your month.

Here are some tips for trading this or any other system:

  1. Gain confidence by first trading a system on paper.
  2. Make sure you can successfully trade a system mechanically before attempting to add any discretion.
  3. Track your actual performance against the mechanical system at the end of each day, rating your success by whether you can match the system's performance.
  4. Monitor performance over an adequate sample, perhaps 100 trades or a set number of weeks. Do not let a down week or trade deter you.
  5. Manage the exits rather than filter the entries. It is impossible to tell in advance which trades will be the good ones. The one entry skipped might be the BIG ONE, and one can't afford to miss it. Managing the exit means two things: The first, learn when it's okay to let that occasional great trade run an extra hour or two before getting out; the second (which really depends on one's skill level), learn to recognize a bit sooner when a trade is not working and exit just before the stop is hit.
  6. All systems display subtle nuances and insights into the market's behavior over time. Keep a notebook of your observations and patterns you notice. In this way you truly "make the system your own".
  7. Never be concerned about how many other people are trading systems. If slippage seems excessive, it often suggests a significant breakout from a triangle or period of congestion. Remember: Something had to drive the market far enough to penetrate the breakout point in the first place!

If you are interested in reading more on the principle of range expansion/range contraction, Toby Crable pioneered some of the finest research in this area. I would strongly recommend his book Day Trading with Short Term Price Patterns and Opening Range Breakouts. The research in this book provides one of the most solid platforms for developing volatility breakout systems based off the opening price. Toby is a CTA who now manages over 100 million dollars based on some of these techniques. Another excellent value is Curtis Arnold's book, PPS Trading System. He discloses a different type of system based on breakouts of traditional chart patterns as identified in Edwards and Magee's book Technical Analysis of Stock Trends (another classic book which should be in every serious market technician's library!). Curtis's original system sold for over $2,000. The book is essentially the same thing and sells for less $50! These books, in addition to many others (including Street Smarts), can be ordered over the internet by clicking below: