How to train to be a trader?
If only I could see 5 seconds into the future, I would find out where the price of commodities and world currencies is going in advance to turn myself into a rich man. Unfortunately, I cannot go further in time, therefore I need to use the traditional market analysis approaches, which are, the fundamental, and the technical.
The fundamental analysis tries to predict prices by understanding the events that affect them, for example, 1) the finding of a massive oil deposit could lower the oil price for the next months due to an increased availability, 2) an earthquake in Chile could compromise the extraction of copper from the mines, and increase its price, since 1/3 of the copper of the world is extracted from Chile, 3) a strike in South Africa could reduce the extraction of platinum, which would be critical in its price since 70% of the platinum is extracted from South Africa.
On the other hand, the technical analysis seeks to predict prices by identifying patterns or geometrical figures in historical price charts. This will be the type of analysis discussed here, and we will use it to develop a strategy to apply in the market. It will not always work in our favor and consequently will make us lose some money, but the idea here is that we will win more than we lose in the long run. But more important to get some quick profits, is to learn to train to be a consistent trader or, in words of Mark Douglas in his book, Trading in the Zone, we are going to turn ourselves in the casino and not in the player in the chair.
CAUTION: THIS ARTICLE IS FOR EDUCATIONAL PURPOSE AND NOT A MANUAL TO TRADE IN THE MARKETS. THE STRATEGY PRESENTED HERE IS JUST AN EXAMPLE THAT I HAVE SHORTLY TESTED AND I CANNOT GUARANTEE ITS EFFECTIVENESS IN THE LONG TERM.
Basic interpretation of candlestick charts
The most common way to show price movements in a period of time is with candlestick charts. Here, each candle corresponds to a period of time, such as, 5 min, 15 min, 1 h, 4 h, 1 day or other. Each candle has an opening price and a closing price, as well as a maximum and minimum price for the period. If the opening price is lower than the closing price, then we can say that the price went up during the period, whereas the price goes down when the opening is higher than the closing. The movements and shapes of these candles can already be used to predict future candles and therefore future prices, but traders can also add some technical indicators such as the simple moving average of past periods to aid them with their analysis and find out the optimum time to buy and sell.
Technical indicators used
Now, I am going to describe you the 2 indicators I want to use to develop a strategy. The first one of them is the Donchian Channel, which is a channel in the candlechart that indicates the highest and lowest prices for certain quantity of past periods. Therefore, the channel becomes narrower as the number of periods is decreased.
The other indicator is the Fibonacci Retracement, which indicates a retracement in the price towards levels based on the Fibonacci sequence. The idea here is that if we manage to identify a retracement towards a Fibonacci level, then there’s a chance that price will head towards a higher Fibonacci level. As an example, a retracement from 1 to 0.618 will probably announce a movement towards 1.618, as shown in Image 3.
Developing a strategy
According to Mark Douglas, participating in the markets offers traders an unlimited freedom to express their creativity. With this in mind, I want to describe I strategy that I recently started testing to buy and sell West Texas Oil using the Donchian channel and Fibonacci retracement as described next.
1. Identify when the lower limit of the channel is pushed down. This will be the Fibonacci level = 0.
2. Identify when the higher limit of the cannel is pushed up. This will be the Fibonacci level 1.
3. Wait until the price returns to level 0. If the upper channel is pushed further up during the wait, then the level 1 needs to be updated.
4. Buy when the price touches level 0.
5. Sell when price reaches level 0.618.
However, if the price doesn’t go to level 0.618 but continues towards level -0.382 instead then we need to accept that things were not in our favor and accept a small loss. The idea here is to develop a strategy that wins more often than it loses and that earns greater amounts than it loses.
So, once the rules are written, we need to analyze previous data to test the effectiveness of this strategy. I did it for the past one year using 1 hour candles and managed to identify 28 events with 3 possible scenarios.
· Scenery 1: Wins at level 0.618 and loses at level -0.382.
· Scenery 2: Wins at level 1 and loses at level -0.5.
· Scenery 3: Wins at level 1 and loses at level -0.382.
As you can see, scenery 1 is the one with more wins and less loses, but, is this also the scenery with more profits? Well, assume that you risk to lose 1 dollar every time a lose level is achieved. Then you will get more than 1 dollar with every win, and the next profit after 1 year.
As you can see, even that scenery 1 is the one that wins more often, it is not the one with more profit during the year. In this case, scenery 3 looks for greater wins with lower loses. However, the optimum win/lose ratio varies from person to person and depends on how much they are willing to risk.
Final thoughts
In this article, I have shown you how to propose and test a strategy to analyze the markets. Ideally, your proposed strategy should earn more money than it loses by winning more often than it lose, and by earning more when it does than when it loses. Once your strategy has been successfully tested, your mission will be to execute it at every event identified without fear to lose and without greed to earn more than originally planned. This way, you will be the casino and not the player in the chair. However, I warn you that this sounds easier than it is.
