Q&A
Futures For You
Inside The Futures World
Want to find out how the futures markets really work?
DeCarley Trading senior analyst and broker Carley Garner responds to your questions
about today’s futures markets. To submit a question, post your question
at https://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C. Visit Garner at www.DeCarleyTrading.com. Her books, Commodity Options and A Trader’s First Book On Commodities, are available from FT Press.
FINDING THE BEST METHODS
There is an unlimited number of theories in technical trading, so what do you believe offers the best opportunities to the average trader with limited capital?
When it comes to technical analysis, there are three primary schools of thought with significantly different views on the markets: trend trading, breakout trading, and countertrend trading. Whether a trader is looking at an intraday time horizon using one-minute price bars or a monthly time horizon using weekly price bars, nearly all futures trading strategies (but not necessarily options) will fall under one of these umbrellas. Which method will work best for any given trader will depend on his or her personality and overall view of the markets, but here is what I have found to be the most productive method. That doesn’t mean you have to agree with me, but I hope it will provoke some thought on the matter.
In its simplest form, trend trading often incorporates the use of a combination of moving averages and technical oscillators to create relatively slow entry and exit triggers. This is because the goal of trend trading is to catch the long-lasting rally that isn’t necessarily frequent but can return substantial profits once it does occur. Because of the nature of the analysis and strategy, trend traders are slow to buy into a rally and therefore often relatively high prices of a move; conversely, they are often late sellers into a bear move and tend to sell low in hopes of the market going even lower. Simply put, trend traders require the market to move considerably before a trend is established rather than attempting to pick tops or bottoms.
Due to lagging entry signals, trend traders face dismal odds of success on a per-trade basis. Nevertheless, the premise of the strategy lies in the expectations of eventually catching a dramatic market move in which the gains are so significant they offset the frequent losses that can take place before catching a ride in the market.
A smart trader once told me, “Buy ’em when they cry and sell ’em when they yell.” Keep that in mind.Breakout traders are similar to trend traders in that their strategy seeks the relatively rare price move that could return blockbuster returns. Therefore, it isn’t surprising that they also tend to have low win/loss percentages.
These traders focus on trading channels and attempt to profit from a futures contract that breaks above resistance or below support. Doing so assumes that a break of technical barriers will lead to a continuation of the move in dramatic magnitudes.
Also similar to trend traders, breakout traders require the market to substantially move in the intended direction before they are willing to enter. Accordingly, this strategy comes with the same difficulty of buying at high prices and selling at low prices. Nonetheless, such traders believe that a true market breakout has the potential to more than cover the losses sustained on “false” breakouts.
Although it goes against human nature and isn’t necessarily the most popular approach, the most efficient means of technical analysis might be in relation to countertrend trading. Rather than using tools and indicators to identify a trend and go with it, traders might be better off determining overextended market conditions and trading against the tide. If the goal is to buy low and sell high (which it should be), being bullish near-technical support in an oversold market and bearish near-resistance in an overbought market should offer the best odds of success.
Trader Peter Lynch once had the following to say about trading in the stock market: “The one principle that applies to nearly all these so-called ‘technical approaches’ is that one should buy because a stock or the market has gone up and one should sell because it has declined. This is the exact opposite of sound business sense everywhere else, and it is most unlikely that it can lead to lasting success in Wall Street. In our own stock-market experience and observation, extending over 50 years, we have not known a single person who has consistently or lastingly made money by thus ‘following the market.’ We do not hesitate to declare that this approach is as fallacious as it is popular.”
The premise of countertrend trading is simple: most people lose money trading commodities. Therefore, simply following the pack is probably going to produce negative results. In addition, if everyone is getting overly excited about the current market move (whether it be bullish or bearish), prices will eventually reach a climax. After all, in a bull run, once all of the buyers are in and the shorts forced out (cover their positions by buying contracts back), who is left to buy? A smart trader once told me, “Buy ’em when they cry and sell ’em when they yell.” Keep that in mind.