A reader wrote me and asked me about my ES trading methodology. I think he expected a detailed technical discussion, but that’s not what allows me to succeed. Instead it is a combination of 3 things I have learned.
You asked about my ES trading methodology. I think you may really be asking a different question: “what do you do and why does it work?” What I do as I set about trading the ES is the result of 7 years of banging my head against the wall. (I think I may be the slowest-learning trader in history.) But I seem to have figured out some things, things that work foe me anyway. I am right more than wrong and my equity curve moves consistently north rather than consistently south. I believe the secret to my success is a three-part combination of traits or habits I have developed:
- Good money management
I have learned the hard way that I cannot succeed trading any system or technique I don’t truly believe in. Furthermore, I can only succeed trading in a way that is fully consistent with my beliefs. Let me illustrate by contrast.
I know a lot of traders try to make money by taking 2- to 3-point profits on the ES many times throughout the day. I do not believe that I can make money trading the ES that way. (I have tried.) I am not saying it can’t be done. I am saying I do not believe I can do it.
On the other hand, I do believe that I can make money on the ES on a slightly longer time-frame. My first trade this year lasted a week. I made 20 points profit on each contract on that trade. My second trade of the year was the one you I wrote about earlier this week. it lasted about a day and a half. I made 20.25 points on that one as well.
I know that my beliefs about the ES result from my experiences. I failed rather spectacularly trying to trade on a shorter time frames, and I have been watching the bloody thing for 6 years trying to understand it. After all that time and all that experience, I feel as if I have a pretty good handle on how it normally behaves day-to-day; the result is that I have the belief that I can trade it successfully.
I don’t think I can over-emphasize how important this belief is to me. Without it, I could not be profitable. You won’t be consistently profitable without it either.
Because I have belief in my own ability, I am able to do two very important things while trading:
- I can wait for the entry signals that I am expecting to occur before I attempt to open a position.
- After entering, I can wait for the exit signals which I expect to occur and not jump the gun.
It is important to understand that my patience is the natural fruit of my belief, and my belief stems from my understanding. Since I “understand” how the ES behaves over the time frame in question, I have an expectation for how my trades will unfold. My expectation always has three components:
- A Stop Loss trigger
- A Profit Target (or 2 or 3)
- A Time Limit
I’ll talk about those in detail later, but suffice it to say that I have the patience to wait on one of those three things to occur. When one occurs, that is my signal to exit the trade.
When it presents itself, I like to use support or resistance (S/R) levels for my stop-loss areas. However, that seldom happens. Instead, I manage my money like this:
Once I have identified a trade, I calculate how much I expect to make on that trade. Then I calculate how much I am willing to risk in order to make that amount. I believe in thinking like a poker player. Just as good poker player calculates his pot odds on each bet, I believe I should calculate the risk:reward ratio for each of my trades. As a general rule, I will risk 1/3rd of the amount I expect to make. So, if I expect to make a minimum of 20 points, I will risk a total of 6.75 points. I never go into a trade without knowing exactly how much I am willing to risk.
Also, if I maintain that approach, then I can lose 2 out of 3 times and still do no worse than break even. My goal is to be right 50% of the time. That way, I will make money.