Ten Principles of Trading That Made Me a World Cup Champion Trader
By Rob Mitchell, IndicatorSmart.com
I have managed to make my living as a trader for more than 20 years in an industry where most traders only last a few years and where most people lose. Looking back, the journey has had a lot of good lessons. What I have learned over that time that really works can be reduced to some basic principles. Over this period, I have continued to learn and refine these principals. In this article I am going to share some key points that can help you in your successful journey over and over again, particularly as it applies to the intra-day action in fast-moving commodity markets.
How you organize your charts can make a big difference in whether you can identify worthwhile patterns. If you are trading in higher timeframes like daily or weekly charts, this will not matter as much. But as you go into smaller increments, time-based bars become less meaningful. In the intra-day frames, price bars constructed based on order flow and range are typically the very best.
The most basic form of a bar based on order flow is a tick or volume-based bar. These bars can work well for intra-day action, but the bars themselves do not have characteristics that give information about trend. For this reason, they come up a bit short on providing good information about price action.
The way you construct a volume- or tick-based bar is you sum the volume or number of ticks until the given threshold is met. Once met, you begin a new bar. Because the bars are based on total volume or ticks, there is no component of the bars’ construction rules that would cause the bar to close in the direction of the trend. In fact, these kinds of bars tend to close in the middle of their range.
On the other hand, a bar that uses order flow computations to construct the bar will tend to close at the high or low of the bar in the direction of the trend. When you have this capability, you can read trend in an extra dimension that is occurring at the execution level on your chart. This in itself can provide an excellent edge in your intra-day trading. But there are actually more benefits than just this when you combine it with points we will discuss later in this article.
Below is a chart of ultimate tick bars that is an example of a price bar that is constructed based on order flow computations. Compare it to a similar tick bar chart directly below that:
Note the chart on top (ultimate tick bar - UTB). It tends to close at or near the high of the bar in an uptrend and at or near the low in a downtrend. The tick chart tends to close at more random points in the bar. UTB charts tend to also have smaller bars when the market is trending and larger bars when it is not. During these same times, a tick- or volume-based chart will actually generate more bars and plenty of bars in consolidating markets.
This is an important concept for a variety of reasons, but the most basic reason is: this is good data to feed into your indicators and to use to read price action on your charts. When data is organized by the very factors that cause price movement in the intra-day time frames, interpreting movement is simplified. For example, if we are feeding an oscillator or moving average data from the tick chart above, there are about 26 bars going down from 8:55 AM compared with only about 10 bars on the UTB chart. This cleaner data has a large impact on an indicator function.
Another bar type that works better in the intra-day time frames is the range bar. There are various types of range bars, but the one I have settled on as being ideal is the Smart Renko bar. This bar is constructed by generating a new bar each time the given number of ticks are met in vertical range. Secondly, if price reverses, the bar is twice as tall as one that is continuing. These we call reversal bars and continuation bars respectively. The chart below show this construction:
Note the Smart Renko chart above shows the action we have been discussing on the earlier two charts in only about 10 bars total. The construction of the Smart Renko has a whole host of price patterns that work well for managing trade entries and for trading in open zones that we will discuss later in this article. Smart Renko also works well, of course, for analyzing range movements and for feeding relatively constant data into indicators for more accurate reading.
As markets trend, the cycles become longer. As the market consolidates cycle lengths become shorter. This may be one of the most important things I ever learned in trading. We already talked about how the UTB generates more bars in a trend and fewer bars in consolidation. This pattern is true in other frames as well, such as on the Smart Renko we have been discussing:
A cycle of six is followed by a cycle of 14, so the cycle is expanding. Note: this tendency applies to both range and time computations and for tick-, volume- and UTB-based bars as well. On the left side of the above chart there are clusters of bars and in various cases, multiple reversal bars. We call these patterns railroad ties and they are associated with non-trending/short cycles.
Now that we have described the expanding cycle idea, we can move on to being able to identify trends before they even occur. The tool we will use actually analyzes the cycle lengths in two different dimensions and adjusts itself to the cycle length. In other words, this is an adaptive indicator that adapts to the cycle length expansions and contractions and enables us to see cycle expansions even before they can be seen on the chart in some cases.
The tool we will use to do this is called the smart momentum, and it is at the bottom of the chart above. Note the slanting magenta line drawn on this chart on the right. You can see the smart momentum is lower over the 14-bar zone we counted earlier than it was on the six-bar pattern. This is indicating to us that the price cycle is up and the cycle is expanding. Therefore the trend is up.
Note further to the left another magenta downward sloping line that is higher than the previous momentum swing but also where price is lower. Smart momentum is telling us here that the trend is down even before a full cycling of price has occurred from the high just before the time of 1:11 on the chart. This is an example of identifying a trend even before it cycles using this range expansion concept.
I call this general pattern a type 2 divergence pattern. And for the case on the left above, we call it a non-cycling type 2 pattern. Learning to identify these patterns is of excellent value, particularly where the range expansion for the day has not yet fully manifested. This is a topic we will discuss shortly.
Trading with the trend tends to stack things in your favor. There are really only two kinds of trading. Trend trading and counter-trend trading. You can also mix the two. In the above examples with the type 2 divergent pattern, we are looking to take a trend trade where the market is pulling back from a trend that is occurring on a slightly bigger time frame. This is technically a counter-trend trade with the intention of catching a bigger trend. One can also trade only with the trend. In this case, a true, pure trend trade is called a breakout trade. In this case a trader would be more likely trading at or near new highs or new lows. A pure counter-trend approach would be selling new highs and buying new lows.
These three basic types of trading systems or approaches have in general certain statistical profiles associated with them. For example, if you told me you had a trading system with a high win percentage but where the average winner is less than the average loser, I would envision a counter-trend trading system. If you were to say your system had a fairly low win percentage but the winners were much larger than the losers, then I would envision a trend system. If it was in between, I might envision a hybrid of the two basic system types. Because most markets trend over longer times and counter trend over shorter periods, there is a bit of a statistical advantage to trend trading in general.
If you can manage to build a system or approach where the win percentage is high and the average winner is bigger than the average loser by any margin, you will have a trading system that takes the best from both approaches. This is of course, a big topic, too much for the space of this article, but for our purposes here a hybrid approach is preferred, especially if it can be aligned with other ideas we are discussing in this article.
Markets like to move quickly through areas of low volume and slowly through areas of high volume. For our purposes here, let's define areas of low volume as an "open zone." On a chart, an open zone can look like a variety of things. One example is to look at a 30-minute chart and see where price did not overlap other 30-minute periods. Why use a 30-minute chart? Because market profile traders use 30-minute charts, and it is a large group of fairly well capitalized traders. But, the same principals we are discussing here can be applied to the Smart Renko we have discussed and the UTB, as well as other charts. In the simplest form, markets do not like to leave holes on the 30-minute bars:
The chart above is a 30-minute day chart. The areas pointed out on this chart (not all areas are marked) we call chart "anomalies."
In review, areas of low or absent volume are traversed more easily (and often very quickly) and areas of congestion with more difficulty. Trading trends into the open zones can be some of the most rewarding trading you can do. Learning to know where these areas are on your chart and positioning yourself with the trend through these areas can be well worth waiting for.
Using simple statistics to identify an edge is a big part of success, and particularly as it relates to range expansion. Let's say we knew a way to compile statistics that would tell us when there was a high probability the market was going to move a given distance. Would that be of value to you as a trader? This is the exact principal I want to teach you now. There are many ways to do this, but I will show you one good one for the purpose of construction.
Each morning, the market opens and it is guaranteed the market will move from that open. After all, there is no such thing as a zero-range day, right? So, we can simply make a statistic about how far it goes. Simple, right? OK, after the first hour of trading, the market range is used by 30-minute (market profile) traders to balance and evaluate positions. This range is called the initial balance period (IBP).
In most markets, the range will expand out of this area by a ratio of the IBP. In crude oil, the IBP 1.5 level is hit on over 80% of days. This means you have a trading system with an 80% win rate every day based on this number. To get this number, simply take the first-hour range and use a Fibonacci extension tool to expand it out 150% (see your chart vendor's documentation for more information on how to do that).
Here is another nice stat. The IBP 200% level is only hit on less than 50% of days and only closes through that number < 25% of days. This is true in crude oil, but you can easily test (and should test for yourself) this by making counts.
Many very high-percentage stats can be derived by simple methods like this, and they really work! This means you trade for the expansion with the trend as we have described herein.
Another amazing point just as valid that we already discussed: do you want to take a trade when you are beyond this point by any margin? No, because savvy traders know where these levels are. Initiate your trades earlier before the expansion and ride your trades into areas where the stats no longer support your trade. Now you are trading like a real pro! Does this mean the market will not continue? No, it just means what the statistic supports. Then from that point, other methods come in to play.
The best trading systems are made of actionable collections of ideas.This is a great concept! Imagine you have all the above resources, and a good collection of statistics you know. In this case, the chart as it is unfolding during the day becomes an adaptable trading system that can be read based on the patterns, each of which is independent and has a statistical edge associated with it.
The very best trading systems ever devised are based on this principal. The more components you can bring together, the better the system. Simply align multiples of these things in your favor and watch the market move in your direction and with good range. You will want to be patient and take the ones that align. In the moment, this is like solving a puzzle when you are a kid. You search for the pieces and assemble the puzzle, even anticipating how the puzzle is making itself up as the market unfolds. This enables you to experience what most traders never imagine—watching your hypothesis as to market action unfold before your very eyes, and knowing it is in alignment with high probability statistics. As you do this, you will find another benefit: this will lead to your seeing an understanding market movement in new and unique ways. It is very rewarding and fun
Patterns of price action are key to understanding market movement. Above, we talked about price patterns on the Smart Renko bars. Smart Renko bars have the unique form, as you recall, of being 10 ticks in the reversal and five ticks in the continuation bars (this can be adjusted). The patterns we are about to discuss can be seen on all different kinds of charts, but the structure of the Smart Renko lends itself to the patterns below. One pattern is the “pivot retag.” A pivot is any area on the chart where you have a reversal bar:
These pivot retags occur over and over again all day. Some price movements fail to retag, but this structure can be key not only in finding excellent trade points, but in managing risk and trade targets. Note that not all points are marked in the above chart. You can even define trend based on this concept.
You have to make it your own. I have been training traders for many years, and if I have learned one thing it is this: following another trader beyond learning some basics will not lead to success. You have to make it your own.
This can be done by having a known, experienced trader assist you in an appropriate and supportive learning environment. Strive to rely on your own internal model of the world and get it aligned with the truth of trading as soon as you can. Getting yourself to a level of self-reliance will pay you back many times over for the effort and you will feel better about it, too. Look to the inside for your guidance and let it prosper you!
You have to operate like a business. We have talked about using statistics in this article and other concepts and ideas that line things in your favor. A business has some basic procedures for operating, and a trading business is the same. Businesses are based on principals established in reality and relationships that have measurable value. Trading is the greatest business in the world, but it is also pure capitalism and in the intra-day time frames, it is more-or-less instantaneous pure capitalism. This is a gift because this feedback mechanism can lead to profound learning, personal advancement and growth.
Your head has to be in the right place. There are principals operating in trading that are inconsistent with the way most humans are wired. In addition to making my living as a trader, I am also a Board-certified NLP practitioner, Time Line Therapy® practitioner, hypnotherapist and NLP coach.
Working in this area has provided me with the amazing opportunity of seeing people's lives transformed as traders. Above we mentioned becoming self-reliant. This is important, but it has to be done while aligning other principals to be highly effective. For example, if a trader is carrying a lot of negative emotions, it will disable the capacity for growth and for a positive future.
This is not speculation, and it is well known by the medical community all the way down to the cellular level. Basking your body in a positive body chemistry frees the body to do what it does best; create. Therefore, it is imperative you positive-ize your environment and your mind for all varieties of good health. Doing this is beyond the scope of this simple article.
If you find yourself repeating the same behavioral patterns over and over and not getting better results, this can often be remedied with the right resources. You are not your behavior, and you are trading with the good intent of improving your life. This is a noble cause. Reach out if you are interested in a personal breakthrough session.
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