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Discretionary Trader

What Is Discretionary Trading?

Discretionary trading basically means you do your trading by hand. You take your signals from a variety of sources, or you have a specific strategy or set of tools that help you make trading decisions. There is little or no automation, for the most part you are pushing the buy and sell buttons.

We teach people who like to trade the discretionary way, but we do it with a systematic approach. Which means that there are trading rules to abide by, however within those rules there is some discretion on when to actually take the trade.

Advantages and Disadvantages

There are many very successful discretionary traders, and you can do quite well, so long as you are disciplined and consistent. Discretionary traders that know their edge and work within the rules and practice sound money management can and do succeed. But there is also a great deal of risk as well…

That risk is typically born from the inherent fallibilities of being human. We are subject to emotions, like fear and greed, we are also subject to distractions, which can result in costly mistakes being made.

Knowing Your Edge

Most discretionary traders don’t have a firm grasp on what makes them profitable and why, they just go on instinct. It is very rare to find such a person that is consistently profitable.

That is why we teach a sound approach where there is an underlying philosophy and methodology that guides the strategy and tactics. We employ a variation of theme based on a well known strategy that looks at the treasury yield curve.

The strategy is statistically based, so we know the odds of the trade, and we employ methods that stack the odds in our favor. The key to being successful with the strategy is employing sound money management.

This is a variation of the same strategy used by institutional traders in investment banks, hedge funds and proprietary trading firms. The strategy is very simple and can be learned in a few short lessons, and comes with live support. If you would like to learn this strategy, you can schedule your first lesson below. For more information click here.

Or call Ernie directly on his personal mobile phone: (508) 446-0517

Schedule Your Training Here

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How To Get Started AutoTrading

Don’t let anyone tell you that systems trading stocks or futures is easy. I’ve been speculating in systems trading for nearly 15 years. And it wasn’t until I serendipitously found my mentors, did I start seeing success. The following is what I learned, and I suspect it will work for you too.

Step 1. Have a Plan

When you embark on any project of sufficient complexity, build a house, start a business, run a campaign…you need a plan. The same is true for speculating in the stock and futures market. Your opponent has a plan…this is a competition, there are winners and there are losers. The winners plan well.

Step 2. Find a Strategy

This is the most difficult part of developing a trading system. Because most people think its about finding A super strategy that works. The reality is that it’s not about finding a killer strategy, it’s about developing a process for creating a continuous stream of adequate strategies.

Step 3. Curate, Check and Test

This is perhaps the most important step, because it’s the gate you open to running your money. You need to check and double check your work, strategies should be back tested, forward walked, and run in simulation mode against realtime data before you commit it to real money. If you can peer review it, that would be a very good thing to do as well.

Step 4. Execute Your Strategy

This is the big moment, when you pull the trigger and trade your strategy with real money. This is when all your planning comes together, you are now a fund manager. Don’t deviate from the plan, stick with it, at least for three to six month campaigns. Anything less then random chance could make a good strategy look bad.

Step 5. Monitor, Measure and Adjust

As soon as you start trading, it’s essential that you monitor your results. Your plan is not static, it’s about continuous improvement. Keep a trade log, develop relevant statistics, note all anomalies, then review the performance of your system on a periodic basis. Use what you have discovered as input to the next round, the next campaign.

Conclusion

Whether you know it or not, when you trade, it’s a business, and it requires the same kind of attention that any business that you intend to succeed at should have. These are the steps I have used and found success. It takes time to settle in and get everything running smoothly, but it will be worth it.

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Statistical Arbitrage Is Not Rocket Science

I’m going to say it right up front…you don’t need any special knowledge to use Statistical Arbitrage, also known as StatArb. All it is, is a fancy name for pairs trading. But even that term, pairs trading, makes some traders unsure. It has too many moving parts, and people struggle to understand how one profits by buying one asset and selling another.

But it’s not that complicated, StatArb removes the one thing from analyzing the markets that is so difficult to achieve, and that’s predicting direction. StatArb is agnostic to direction, it allows you to profit under conditions that might normally seem untenable. The amazing thing about a StatArb trade is that it trades the relationship between two correlated assets, which by its very nature provides a well defined and highly probabilistic edge.

Another great thing about StatArb is that it provides risk aversion in a naturally hedged position, you don’t have to care which way the market goes, and with futures you get substantial discounts on the cost of the trade. And all you have to do is follow a couple of very simple rules.

Is StatArb a fool-proof methodology? No, but it does remove most of the things that haunt directional traders. The only real problem with StatArb is the availability of easy to use, and intuitive tools across popular trading platforms. That’s probably the principle reason that retail traders have not adopted the strategy.

How Does StatArb Work?

The whole premise of a StatArb pairs trade is to match two highly correlated assets and trade the difference in value. This difference in value represents the change in relationship. If two things are very similar, and the relationship gets disrupted, there’s a high probability that the relationship will eventually regress back to its norm.

So, the way you trade StatArb pairs is wait for a disruption, measure that disruption using statistical measures, typically one standard deviation, then take the trade by going long the underperforming side of the pair, and short the over performing side. Then you make money as the pair regresses back to their norm, closing that gap between them.

The probability that the divergence or disruption will repair itself is very high if the pair are highly correlated. Which basically means that they move with each other under all kinds of conditions. You can measure this level of correlation using statistical tools. The most common way is to measure the pairs correlation coefficient, which has a range of -1 to +1. A score close to +1 means the pair is correlated. Most StatArb traders consider a score > 0.5 to be good enough to trade.

There are mathematical proofs that show very high correlations (> 0.70) make the probability of a regression virtually a given, greater than 75%. This is the kind of edge traders dream of.

How Do You Chart the Relationship?

Most trading platforms allow you to include 2 or more symbols on a chart, then use scripts to plot the relationship. Some platforms do it better than others. Let’s look at Think or Swim (ToS) for example. To plot two stocks or futures is very simple, let’s look at the Gold and Silver ETFs GLD and SLV respectively. You can enter the simple formula “GLD – SLV” in a chart and ToS will plot it.

By the way, there are lots of great tools for calculating correlations of stocks and ETFs on the web, here’s one specifically for ETFs. Below is a chart created with TradeStation, using special indicators that plot the pair for you. There’s also a Correlation indicator showing the running correlation Coefficient, currently at 0.51. The correlation shows that the correlation has been steady, hovering a bit above the 0.50 mark.

 

Both these charts plot the value of one share of GLD minus the value of one share of SLV, currently at $101.34. You can apply any kind of traditional charting tools and indicators to determine buy and sell points, just like any single stock or ETF or future. But because we are doing statistical Arbitrage, it is generally accepted that you will measure pivots points using statistical tools. A very common tool to use is called Z-Score. It’s shown below.

A Z-Score indicator is similar to an RSI or Stochastic, but it shows the number of standard Deviations the pair has moved relative to a zero line. The indicator below has a 2 standard deviation alert line that generates a signal when the pair has moved that amount. These are potential places that you might use to take trades

The chart above is for illustrative and educational purposes only. I’m not implying a trading strategy or recommending that these trades should be taken. In fact, there’s still more work to do before you get to that point, just like any strategy. But keep in mind, we’re plotting the relationship between GLD and SLV, not the direction of any one of them, so our strategy should be predicated one that idea.

While some people might just plot the two ETFs and think that’s good enough, but it’s not. You need to make sure both assets are equally represented in terms of their underlying value, also known as the Net Asset Value (NAV). In other words, you have a ratio of shares that represent an equivalent value of gold and silver. There’s a fairly substantial amount of academic and practical research that shows this is necessary. With an ETF this requires some research. With futures it is a simple calculation of multiplying the quoted futures price by the asset’s Big Point Value, which is a component of every futures product.

My TradeStation indicator, which I developed, plots pairs of assets, and automatically does the value calculation for you when you apply two futures products. You can also specify any ratio of contracts you want. Some pairs require a certain ratio in order to get the full discount on your margin requirements. This is a feature of futures, not stocks and ETFs, where the Chicago Mercantile Exchange determines this discount based on their reduced risk calculation as a result of your hedged position. In other words, it’s cheaper to trade futures when doing StatArb than stocks, and you get way more leverage and tax benefits too.

How To Execute a Pairs Trade

This is the final thing you need to know in order to execute a pairs trade. You must execute both sides of the trade simultaneously. Do not try tole into a trade by executing the long then the short or vis a versa. You may get away with it a couple of times, but eventually you will experience pain. But don’t fret, there’s a super simple way to execute both sides of the trade at the same time. It’s a feature in most trading platforms called Order Sends Order (OSO). You simply setup the OSO order and execute it with one button click.

TradeStation has something called Staged Orders in the TradeManager that lets you set up OSO orders. Think or Swim has a couple ways to do it, the easiest is to use their Pairs Trading Platform. The other way is to set your order to Blast All and add both sides of the trade to your order list. And that’s it!

Conclusion

Once you have done these few required things, trade a correlated pair, execute the trade simultaneously with an OSO order, you are good to go. You just need a plan and a strategy, and you can become a Statistical Arbitrageur, making high probability trades, without a care as to which way the market is going.

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How To Trade Oil Futures – The Basics

Crude oil (CL) is one of the more active commodities to trade. It has tremendous volatility and excellent liquidity. Oil is affected by global economic and political conditions, almost to the same extent as US Treasuries. The price of crude oil affects the price of many other assets, including stocks, bonds, currencies and even other commodities. This is because crude oil remains a major source of energy for the world and is a defect currency in many ways.

Crude Oil Contract Specifications:

  • Ticker Symbol: CL
  • Exchange: NYMEX
  • Trading Hours: 9:00 AM – 2:30 PM EST.
  • Contract Size: 1,000 U.S. barrels (42,000 gallons).
  • Contract Months: all months (Jan. – Dec.)
  • Price Quote: price per barrel. Ex $65.50 per barrel
  • Tick Size: $0.01 (1¢) per barrel ($10.00 per tick).
  • Last Trading Day: 3rd business day prior to the 25th calendar day of the month preceding the delivery month.

Cude Oil Fundamentals

  • Light Sweet Crude Oil is traded on the New York Mercantile Exchange (NYMEX). “Light Sweet” is the most popular grade of crude oil that is traded.
  • Crude oil is the raw material that is refined to produce gasoline, heating oil, diesel, jet fuel and many other petrochemicals.
  • Russia, Saudi Arabia, and the United States are the world’s three largest oil producers.
  • When crude oil is refined, or processed, it takes about 3 barrels of oil to produce 1.5 barrels of unleaded gas (RB) and 1 barrel of heating oil (HO).​

Crude Oil Reports

This report is released every Wednesday at 10:30 PM EST, unless there’s a holiday, then it’s released on Thursday at 11 AM EST. The report is usually considered bullish if the actual reported inventory is significantly lower than the expected inventory level, and bearish if it is higher. We say usually because there may be other factors that could affect how the market perceives the report, such as seasonal conditions, or storage anomalies.

TIP: On the days of the report, if you are a day trader or scalper, my experience says don’t trade Crude Oil between 8:50 Am and 10:35 AM EST. The market is erratic on report days during these hours. Wait until the report has had a chance to settle and the market digests its content before trading.

Price Movements

The price of crude oil (CL) is highly correlated to the economics of gasoline (RB) and heating oil (HO). In fact, all three of these contracts are often traded together either for hedging by refiners, or speculation by professional traders in what is called the Crack Spread.

The Crude Oil market is by and large a trending market. There is a high level of volatility however, which can cause price to jump or plummet. These spikes are typically followed by a regression back to the mean direction, unless the event results in a major supply disruption. Crude often gets stuck in prolonged ranges after a big move, identifying these ranges is crucial to exploiting excellent trading opportunities.

The U.S. dollar is a major component in the price of oil. A higher dollar puts pressure on oil prices. A lower dollar helps support higher oil prices. Crude oil also tends to move closely with the stock market. A growing economy and stock market tends to support higher oil prices. However, if oil prices move to high, it can stifle the economy. At this point, oil prices tend to move opposite the stock market. This usually becomes a concern when oil moves above $100. In the past, prices in the $120-130 range bring about capitulation.

Profit Targets for Day Traders

When day trading Crude Oil futures set your profit target between 0.15 to 0.20 cents. This seems to be in line with the intraday swings for the CL contract.

A Target of 0.15 cents with a single full-sized contract translates to $150 ($10/tick or 0.01) and 0.20 cents equals $200, so that’s plenty of profit potential but it’s not going to make outsized demands on your trading strategy like if you were shooting for a lot more, like 0.40 or 0.50 cents. I’m not trying to tell you there aren’t bigger moves, in fact I’ve seen plenty of times rallies go well beyond $1.00 or more. I’m just trying to give you a target that can make profits consistently.

Day Trading Crude Oil Futures

Crude oil is one of the favorite markets of futures day traders. The market typically reacts well to pivot points and support and resistance levels. You have to make sure to use stops in this market, as it can make very swift moves at any given time. It is best to day trade within the context of a larger global macro strategy, rather than rely on pure technicals.

There is no shortage of trading opportunities in crude oil from day to day. The market is very active and it has plenty of volume. Crude oil is a 24 hour market, so be cautious of possible overnight moves that can take you by surprise. Much of the same principles that apply to stock index futures also apply to crude oil futures. If you like trading the e-mini S&P, you will probably like crude oil too.

Crack Spread Trading

In my opinion, day trading technicals is too risky, but many traders find it okay. I prefer to trade a spread, like one of the Crack spreads. My favorite is Crude (CL) vs. Heating Oil (HO) in a 1×1 spread, because of the very high correlation between the two products (r = 0.90 on a daily basis). This provides a level of risk aversion because it’s essentially a hedged trade. The primary trading methodology is mean reversion.

There are other popular Crack Spreads, such as Crude (CL) vs Gasoline (RB), and an all inclusive trade with Crude, Heating Oil and Gasoline, which is usually traded in the ratio of 3x2x1, but this is typically the type of trade a refiner would do to hedge their business

I trade Crude vs Heating Oil, and offer a course and mentorship program for this spread. If you are interested in learning to trade the Crack Spread, contact me at 508-446-0517. And look out for future posts on the Crack Spread.