How
Mentality
Probably the most important factor to trade successfully. Most people keep on a losing trade instead of taking the loss and move on. One important fact to recognize in trading is “there is always a new set up”. If a given set up fails to follow, use a stop loss to leave the trade before losing too much capital on that given trade. Capital preservation should always be the aim. On the contrary, most people leave a winning trade too early. That is why a plan is needed before entering a trade. That trading plan should have clear stops (for stop loss) and exits (for profit taker) levels. Support levels should be used for stop loss and resistance levels can be used to take profits while on the trade.
We deal with probabilities, not absolutes. Counts can and will fail. You need to approach trading based on probabilities, not based on your bias or what you read on the news. You should only trade when those probabilities are in your favor.
Reality
Perfection does not exist, it is a “mirage” out on the horizon that we are continually striving for. Each time it seems to be within our grasp, it gets pushed out a little further and further, again and again and ALWAYS remains just out of reach. Trading is always a constant learning and re-learning game. Perfection does not exist….it is what we can strive for, but will always be on the horizon…. That is why, even if we always tend to strive for perfection, we need to concentrate on being profitable.
Skew
Definition: Your reward on the trade is greater than your risk. The bigger the percentage on the reward side the lower on the risk side. A Risk/Reward of 1:5 has 20% chances of losing against 80% chances of winning.
Math: With a 1:5 Risk/Reward we can be wrong 80% of the time and with only being 20% right we pay for the whole trade. Let’s assume we trade €100 five times assuming the Risk/Reward above. We only need to be right 1 time to cover for all loses. The bigger the skew the more risk we can take on multiple trades.
Scale in approach
Instead of taking a trade with 100% of a position, try breaking down the capital in half (50%) and only invest the first half as follows, building up a position using “tranches” (you can see how retracement levels are measured in here):
When to use the Scale in approach
Always after an impulse. We want to see 5 waves up and we use this system measuring the retracement levels from the last major bottom to the last major top. Here is an example of how to use it: https://www.tradingview.com/x/3NcsJkDz/
When not to use the Scale in approach
When the previous move before the correction was 3 waves up instead of 5 waves up. 3 waves up usually (not always) refer to a corrective move. Meaning the next move might not be a correction to the downside but an impulse to the downside. Trying to catch the bottom of an impulse to the downside is known as "knife catching" and it's a very difficult task because we cannot predict how deep price can go. Here is an example of knife catching: www.tradingview.com/x/kfw9U0uu/
The “core” concept
Using the “scale in” approach we can build a position, taking profits when reaching resistance levels and adding more when approaching support levels. Depending on the asset in question, keeping a small “core” (or small position/tranche) at all times will give us exposure to the upside with minimal risk, specially if we take profits on resistance levels, it’s quite easy to continue on a trade using “house money” (profits of that trade) instead of our original capital. This reduces drastically the emotional factor in trading, when our money is not on the line anymore, we can continue trading that “core” using a “trailing stop order”.
In assets like Bitcoin, using the “core concept” is essential. But that core should be minimal (5 to 10% max).
The “MOMO” concept
MOMO refers to “Momentum” and it’s a complementary way of trading around the core system. It helps remove the emotions out of our positions by doing swing trades around our core positions using tighter stops. MOMO trades are short term swing trades and the key is to use our profits from these trades to increase our core positions. If our core positions are made up of profits, then we managed to remove the psychological factor from trading as “that is not our original money”. Therefore we can let the core positions run freely for longer terms. An example of Core and MOMO can be found in the following link: https://www.tradingview.com/x/CgyLzk57/
Trading plan
Before entering a trade we should know a few things:
Using the scale in approach, we should know what our entry levels are.
What is the skew or Risk/Reward of the trade we would like to take?
What are the stops for preserving our capital and taking profits?
What to do when the trade is against us and stick to it (leave the trade).
What to do when the trade is developing as expected (usually scale into it).
Do not let news interfere with our plan, usually news are a catalyst of something that is set up already.
Remember: we cannot control the outcomes of trades. Yet we can control our entries, exits, position size and our capital outlay.
Perspective and Timing
Trying to time the market on a trade is usually a very difficult task. Yet we know that an extended market is due to a correction. Learning to wait for this opportunities can become quite lucrative as it does not require day trading.
The same is true when a market has corrected more than what is expected. How to know what is expected? Markets usually correct between 23.6% to 78.6% in log scale. Some corrections are shallow and some corrections are deep. Looks at a chart with price history and study the corrections in the past.
Every market behaves different, do not use the same trading approach across markets. First, learn how the market you would like to trade usually behaves (in uptrends and corrections). For example: Commodities and cryptos usually extend more than other markets.
When to enter a trade?
Always at support levels (or retracement levels) using a stop just below the lowest support level.
For example: A given stock has a current price of €5.48. The support levels (calculated by trajectory) are 4.99 (0.382 or 38.2%), 4.85 (0.5 or 50%), 4.71 (0.618 or 61.8%) and 4.52 (0.786 or 78.6%). Given the example from the previous slide we would enter a 10% trade (also called “tranche” or “partial position”) at 4.99 with a stop around 4.5 (just below the 0.786 or 78.6% retracement). We can add to that position using the scale in system, yet it’s important to always use a stop if the setup invalidates.
Risk management
As mentioned already, we are looking for trades with a good skew or good risk/reward ratio. If we are already on a trade, we can easily manage our risk using our positioning. As our risk of a trade increases our position size should decrease. On the contrary, if our risk is very small to our stop, our size can now scale up. Take a moment to read that again and try to understand the key about positioning and risk management. Check the Example of short setup in order to understand how risk should be managed and how to combine it with position size.
Averaging down vs averaging up
Let’s answer the following questions:
Do you feel more comfortable or make a habit of averaging into a position when it goes down or against you?
Or do you increase your line on the way up?
It’s important to do not mistake averaging down with the scale in system. In the scale in system we manage the risk entering a trade using small tranches. Averaging down is when we enter a full position (100%) and once the trade goes against us, instead of taking the loss and move on, we double down.
Averaging up is when we increase our position when the trade goes our way.
Example of averaging up
Let’s say we buy a certain stock today at €50, only a 10% position (using the scale in system), our stop is at €46 and the stock is projected to reach €66. In this example our Risk/Reward is 1:4, meaning we can lose €4 if we get stopped out or we can win €16 shall the trade confirm. Suddenly, the stock goes to €55, not bad right? We are still in our trade but here we can wait for a pullback and add another tranche, let’s say another 10%. After a while our stock goes to €53.5, we can here add another 10% tranche. We should also raise the stop of the first tranche to €50 and also set the stop of the second tranche to €50 as well. Our trade plan hasn’t changed, the stock is still projected to reach €66, yet we have now a 20% position averaging €51.75. However, our new Risk/Reward or Skew is now 1:8. If we’ve got stopped out we lose €1.75 but if we reach our target we can get €14.25.
When to take profits
According to our trading plan we should have defined resistance levels for short and long term. Using the scale in system we can start with a small position and increase it once the trade goes our way. Once we reach wave 3 it’s smart to take some profits off the table. After the correction of wave 4 we can consider deploying a small position for a wave 5 trade, yet the size of that position should be a fraction of the profits we took in wave 3. See the math? No matter if we fail to reach wave 5, we are already in profit because we haven’t deployed all our profits at once. The idea of being profitable is scaling in with small positions and take bigger profits.
When to leave a trade?
If a hard stop is hit (stop loss) we need to check the chart used for the trading plan, zoom out and see the big picture in order to evaluate if the same trading instrument deserves another shot. Oftentimes we can reattempt an entry after a pullback or consolidation.
On a winning trade, knowing when to leave is quite difficult as oftentimes emotions take over our trading plan. As explained in the previous slide, the recommendation here is to take profits along the way instead of taking profits at once. Think of the “scale in approach” combined with the “core” approach we’ve just mentioned. A similar approach can be used to take profits when reaching resistance levels.
Be aware of IPO's
Most people get really excited with IPO's. Until they realize 80% of IPO's are followed by an ABC correction. Here are some examples why you should wait until the correction finishes before buying an IPO.
FB: https://www.tradingview.com/x/zycDe4MO/
KHC: www.tradingview.com/x/bBihqzay/
LYFT: www.tradingview.com/x/G4Fsa4y4/
The 'Commandments' of Trading
Never risk more than 3% of your trading account on a single trade. And use much less than that if using options.
Measure your skew (risk/reward) before entering a trade. Remember: the bigger the skew the smaller the position size has to be to make a difference.
ALWAYS use stops (we cannot repeat this enough).
Professional traders get stopped out all the time so get used to this as setups invalidate. If a set up invalidates just move on to the next set up. You have already calculated your risk and accepted it by the time the order was submitted. Don't hold grudges, it's just a setup.
Save your heaviest positions for the stop region so risks are minimal.
Take profit religiously, and cut risk as we are away from stops.
Keep Elliott Wave counts at a roadmap level and add other approaches to trading.
Be very open to fading you own viewpoint, more because EW stops are very reliable. When they go they really go.
Keep emotions out: trade the chart, not the money. Remember: by the time you have submitted the order you have accepted to take that risk (calculated with the stop loss order).
Learn to be patient. Let the setup come to you, don't chase. Don't buy because everyone's buying. Seek for the next entry, assess your risk and initiate a position when the risk is on your side.