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Know Thyself
Nix The “Get Rich Quick” Mindset
Find Your Niche
The Power Of Detachment
Understanding The Nature Of Trading
Develop A Routine
Guard Against Stress
Never Stop Learning
Never Stop Testing
Consider A Trading Coach
Follow In The Footsteps Of Successful Traders
Play The Odds
Independent Variables
Countertrend Trading
The Donchian Channel – Tracking Extremes
Turtle Power!
Trading On Trends
MACD & Moving Averages
Seasonal Trends
Trend Trading
Current Price?
How Liquid Is It?
How Much Debt?
Entry & Exit Points
Breakout Trading
Size Matters
Some Patterns Are Better Than Others
Pairs/Forex Trading
Dividend Trading
Chapter 8 – Key Points To Remember

While mastering the basic skills required to trade, and eliminating common mistakes are both important, and will certainly make you a good trader, those two things by themselves won’t be enough to make you a truly great one. If becoming a great trader is your goal (and it should be!), then you’ll need to do even more. You’ll need to step up your game, and take things to the next level.
That’s what this next section is all about. Upping the ante. We’ll show you the way!


The Power Of Positive Thinking

You know what happens if you don’t believe you can succeed?
Seriously, if you’re plagued with self-doubt and pessimism, you’re never going to get anywhere. The first step on your journey toward becoming a great trader is to step away from negative thinking. Just leave it behind.
That’s a lot easier said than done, especially when you’re first starting out, because there will no doubt be people around you who look at what you’re doing with a skeptical eye. They’ll tell you there’s just no way to beat the market. They’ll tell you you’re doomed to fail, and if you let them, those thoughts will stick in your mind like a splinter and infect the whole of your thinking.
If that happens, it’s going to wreck your confidence and a cloud of negativity is going to influence your thinking, which is going to hurt both your effectiveness and your efficiency.
On the flip side, believing that you CAN do something goes a long way toward making that true. If you think you can, you’re going to be more apt to look for opportunities to prove yourself correct. You’re going to be willing to take a few well-considered chances and constantly stretch yourself to learn more and master the skills you need to succeed.
Not that you can’t learn the basics in the absence of positive thinking, but having a positive outlook certainly makes the process easier and more fun! All that to say, it matters. It matters a lot. Believe in yourself and your own success. Believe in abundance, and you’ll go far.


Know Thyself

This is another key piece that too many traders overlook. You’ll never be as successful as you could be if you don’t really know yourself, which includes knowing what you’re trading for.
Way back at the beginning of this piece, we talked about the importance of understanding what you’re trading for. What goals you’re hoping to achieve. It’s not really possible to answer those questions until and unless you know yourself.
Knowing yourself is important to other aspects of your trading game too though. For instance, having a firm understanding of how risk-tolerant you are is key to helping you set stop orders to exit trades in such a way that you don’t go into full-blown panic mode when a trade goes south. Sure, you can get to that point by trial and error, but wouldn’t it be so much easier to just know yourself well enough right from the start that you don’t have to guess? Of course it would!
The same thing goes when you’re defining rules for yourself regarding taking profits. If you know yourself, and you have a clear understanding of your trading goals and objectives are, that understanding will help illuminate the precise points at which it makes sense for you to lock in profits. Without that understanding, it’s something you’re going to struggle with.


Nix The “Get Rich Quick” Mindset

A lot of traders enter the game with the mindset that if they find the “right” opportunity, they’ll be able to turn it into a fountain of riches that has virtually no end. That overnight, or in a week (maybe a month), they’ll go from rags to riches and never have to worry about money again.
It would be completely awesome if that were the case, but honestly, if that’s’ how it worked, don’t you think that everybody would be trading?
The simple truth is that like any skill, trading takes time to master. It’s not something you’re going to start doing on Monday, and by the end of your first week, be in a position to retire. Not even the best traders in the world are that good.
There’s no quick path to riches here, and anyone who tells you otherwise is no doubt trying to sell you something. Don’t believe it.
Becoming a successful trader takes three things:
• Patience
• Persistence
• And Determination
You’ve got to have the patience not only to give yourself the time to master the basics, but also to spot those winning opportunities that will start making money for you, the persistence to stick with it and keep refining your strategy, and the determination to keep dusting yourself off and getting back on the horse, even when you face a losing streak.
“Get Rich Quick” thinking has no place in any successful trading operation.


Find Your Niche

The market is a vast, ever-changing place. In fact, it’s so vast that it can cause some traders to be afflicted with “analysis paralysis.” There are just too many choices. Given the amount of research you need to do in order to spot great opportunities and turn them into profits for you, it’s impractical to regard the entire width and breadth of the market as your playground.
Instead (and this goes back to the whole notion of knowing yourself), let your personal interests guide you. If you have no particular interest in commodities, even if you found some great opportunities there, it’s just not something you’re going to be especially thrilled about researching…so don’t.
The market is a really big place, and there are opportunities that cater to every interest, taste and preference. Plus, if you stick with what you know, your due diligence and research will tend to go faster, and that’s important at the margins.


The Power Of Detachment

This is something we’ve talked about before, and the fact that it keeps coming up and we keep stressing it should give you an idea just how important it is.
If you get lucky acting on instinct, you might make a few successful trades and make a little money. If you get very lucky, you’ll be able to avoid catastrophic losses, at least for a little while. In the long run though, trading on the basis of gut instinct and emotion will get you killed.
Emotion is not a substitute for analysis and critical thinking. When trades go your way, keep your emotions in check. Don’t get greedy and don’t get cocky.
Likewise, when trades turn against you don’t panic and make decisions out of fear. Never forget that there’s a reason you took the time to craft detailed exit strategies. Just keep your cool, stick to your plan, and try again when you identify the next trading opportunity, learning from the mistake you made. That’s how you win.


Understanding The Nature Of Trading

While it’s true that emotion has no place in trading, it’s not all number crunching and analysis, either. Granted, those things are vital to your success, but the simple truth is that trading is one part art, and one part science.
Most of this book has been about acclimating you to the science part. The data. The numbers. Helpful formulas. Different types of analysis, and tools you can use to help you in that process.
Here though, we have to give a nod to the role that artistry plays. It’s not art in the same way that painting or sculpting is, sure. No question about that, but developing and refining your trading strategy, then testing it, both in software and in the real world has a certain artistic quality in the same way that composing a piece of music or writing does.
It’s a fairly technical form of art, but make no mistake, if you overlook this aspect, then you’ll never be as effective as you could be.
If you’re wondering what the artistic portion of the equation looks and feels like, look no further than the balance between your winning trades and your losing ones. It manifests itself in the way you limit your losses and let your profits run.
It’s important to note too, that this doesn’t mean you’re relying on intuition or emotion, but rather, drawing on your growing body of experience, and feathering that into your thinking, along with the more technical aspects of trading. Do that, and you’ll take your game to the next level!



Develop A Routine

Muscle memory. It’s a term that body builders and martial artists know well, and it applies to trading as well, albeit in a slightly different form.
Routine matters though, because when you establish a routine and stick with it, it helps you focus your energies on the things that matter most, until they’re second nature to you.
Your trading journal will help you greatly in terms of establishing your routine, and at the end of the day, it comes down to three functional areas:
• Preparation
• Research
• And Review
There’s nothing magic here. All three of these are self-explanatory, but they’re all essential to your long-term success.
If there’s one thing that most new traders tend to gloss over, or overlook entirely, it’s the review time, and that’s something you should be doing at the end of every trading day. The reason? Review is your opportunity to learn. To assess what went right, but more importantly, to assess what went wrong, and in doing so, identify specific things you can do to help ensure the mistakes you made don’t come back to bite you in the future. That’s how you grow as a trader.


Guard Against Stress

We’ve talked about stress before, but it bears mentioning again here, because it feeds into some other things that are critical to your success as you continue on your journey toward becoming an excellent trader.
When you let stress get the better of you, it clouds both your thinking and your judgment. It makes it more likely that you’ll make rash, snap decisions based on instinct, fear, or emotion, rather than rationality.
Not to mention the fact that it makes you a nightmare to be around as a person, and let’s face it, no matter how much you love trading, and no matter how much time you spend doing it, you have a life outside of it, and a variety of personal connections to maintain. Nobody likes being around a grouch, which is why managing your stress is so important.
Besides, what is the point of becoming a successful trader if you’re miserable all the time? You should be doing the things that make you happy, and trading can help you with that. The profits you make from trading can, long term, help you realize those dreams you’ve had to defer for most of your life.
Again though, that doesn’t do you any good if you’re too stressed out to enjoy them, or if stress puts you in an early grave, so managing stress is a lot more important than most people realize.
Fortunately, there are some really easy ways to reduce and control your stress, and while that isn’t the overriding goal of this work, it’s an important enough topic that it’s worth spending some time outlining them, at least in brief.



When you start feeling your stress levels rise, close your eyes and visualize your life and how it will be, once all your trading goals are realized. What will your life look like?
Can you see your dream house? Is it on the beach, or in the mountains? What does it look like? What do your furnishings and other creature comforts look like?
Picture your life, and see yourself in it.
Alternatively, picture yourself in a hammock, staring lazily up at the clouds, or put any other image in your mind that you find soothing and relaxing. Don’t just think about it – see it. In vivid color and detail. Enjoy your little virtual reality mini vacation in your own mind until you feel your stress levels receding. You’ll be amazed at how quickly that happens!



You don’t have to get all new agey for this to work, so you don’t have to sit cross-legged on the floor and chant mantras, although if that’s your thing, by all means do it! You can keep things much simpler though, if you want to.
Just close your eyes, clear your mind, and relax. Some people find it hard to do that. There’s just too much clutter and too much noise for them to shut things out. If that’s the case for you, then you might find it helpful to listen to some soothing, relaxing music, or even a “nature sounds” soundtrack (waves crashing on the shore, tropical rain forest, thunderstorm, etc.).
For other people, what works is a desktop Zen rock garden or similar. There are no “right” answers here. The important thing is to find something that works for you, and devote at least a little time every day to taking your mind off trading and the worries of the day and just relax. Try our Trading Mindfulness commentaries HERE.



This one is both really easy, and incredibly hard. Step away from your computer. Go outside. Get some fresh air.
We saved this one for last, but the reality is that it’s one of the most powerful relaxation techniques you can engage in. Believe it or not, there’s quite a lot of research that’s been done on stress, and scientists know a great deal about what causes it.
Stress is caused by the release of the hormone cortisol. This is the “fight or flight” hormone, and the more stressed out you are, the more of it floods into your system. It’s not healthy, and long term, can lead to a raft of medical issues, some of them potentially fatal.
The good news though, is the fact that it’s easy to reduce cortisol levels. The other two stress reduction strategies are effective, but neither are quite as effective as simply getting outside for a while. Studies have shown that a fifteen-minute walk can reduce your cortisol levels by as much as 25%. Even better, walking in the woods has nearly twice the impact on your cortisol levels as walking in an urban area.
Take advantage of that fact if you’ve got some woods near your house, and go enjoy them!
There’s a lot more that could be said on this subject, obviously. In fact, whole books can (and have!) been written on stress and how to deal with it, but even if all you do is take a little time out of your day and make use of one of these three strategies, mixing and matching as you see fit, then you’ll find that your stress levels fall dramatically. Fifteen minutes a day is all it takes, though by all means, if you need more time, take it! It’s your life. Be happy in it.


Never Stop Learning

Your trading strategy isn’t a “one and done” kind of thing. It’s not something you create, and then use as-is forever, or at least, it shouldn’t be.
It should be in a constant state of flux as you seek, on a daily basis, to refine your processes and improve your analytic skills. In order to do that though, you’ve got to commit yourself to a cycle of continuous learning and improvement.
That means, among other things, reading books on the subject, watching instructional videos, and most importantly, maintaining, studying and learning from your trading journal so you can identify the mistakes you’re making and develop an action plan to keep you from making them in the future.

Never Stop Testing

This is something we’ve mentioned before, but it bears repeating here, because simply reading about all things trading-related isn’t enough. Before you implement any changes to your trading strategy or try out a new idea, you should thoroughly test it so that you’re satisfied that once you begin using it live, it will help, and not hurt your overall strategy.


Consider A Trading Coach

Different people learn in different ways. What works for you may not be an effective learning paradigm for someone else, and some people really struggle with spotting their own mistakes and missteps. If that describes you, then you may find tremendous value in hiring a trading coach.
His job isn’t to make your trades for you, but to help you in all phases of your trading operation. To be available to offer advice, and words of wisdom and encouragement to be sure that you stay on track and on top of things. To point out mistakes when you make them (and you will – that’s a natural part of the learning process).
Of course, hiring a person to coach you has a significant downside: It’s expensive, and if your budget simply won’t support that, then there are two other options available, but there’s a catch: You’ve got to be self-motivated. If you aren’t, then these aren’t going to work for you.
The first option is to use your trading journal and “coach yourself.” The big drawback here (besides requiring you to be self-motivated) is the fact that if you’re not so good at spotting your own mistakes, then this is going to be difficult for you to use well without training.
The second is a bit more promising though. There are self-directed coaching guides you can buy, and these are highly recommended for those who need a bit of a helping hand, but who lack the funds to hire a person to guide them.
They’re somewhat limited, in the fact that, as books, you may develop a specific question or situation that just isn’t covered in the materials, but on balance, these kinds of guides make a great resource, and will serve you well.


Follow In The Footsteps Of Successful Traders

Too often, beginning traders get lost in the weeds, trying to develop their own strategies for trading. Here’s the thing though: You don’t have to reinvent the wheel. The market has been around for a very long time, and legions of traders have already worked out a wide range of winning, reliable strategies.
The best way to find rapid success is to find a trader who operates in a similar fashion to the way you want to, and copy his (or her!) moves. If it’s working for them, it can work for you, and once you get some hands-on experience with it, you can start making tweaks and changes to the overall strategy to truly make it your own.


Play The Odds

One of the most important things to remember about trading is that there are no guarantees. There’s no such thing as a “sure thing” in this game. Even if a strategy has had something close to a 100% success rate in the past, that doesn’t mean it’s going to work in the future. There are simply too many variables, and too many things outside of your control to guarantee that.
At the end of the day, trading is a numbers game. You’ve got to play the odds. If your analysis tells you that a given trade has a (roughly) 65% chance of succeeding, that’s your edge. Make that trade. Sure, it might not work out, but if you keep making trades at those odds, over the long term, you are going to succeed and make money.
A lot of the time though, it’s going to feel like you’re not making much progress. The important thing is to remember that when things start going south, you get out of the failing trades quickly, and let the profitable trades run. Do that consistently, and you’ll find that your account balance grows steadily over time.
Play the odds, and do everything you can to stack them in your favor. That’s the heart and soul of it. By sticking with low-risk strategies and cutting your losses early, you set the conditions for steady, sustainable growth, and that’s ultimately what wins the day.


Independent Variables

Independent variables, when used well and properly, can help to improve your probability of success, which means that they can help you make more money in the long run. There are more than 180 indicators that traders use to evaluate potential opportunities, but did you know that the vast majority of them (over 98%!), are derived from just four pieces of information? It’s true! Most of the indicators you’ll be looking at are based on the following:
• The opening price
• The high price
• The low price
• And the closing price
That’s it. Those are the most fundamental pieces of information in terms of evaluating a position you’re considering entering into, but they don’t capture everything.
So why is it that some indicators are “better” than others if they’re all derived from the same basic information?
That’s where independent variables enter the equation!
The standout indicators incorporate things like volume. See, while price matters, adding volume data to your analysis can change the picture, allowing you to see the opportunity in a new light and bring it into sharper focus.
Volume, of course, isn’t the only independent variable you can use. There are others, including:
• The movement of other markets (currency, commodity, other stock markets besides the one you’re trading in, etc.)
• The market environment as a whole
• The sector environment (how price is moving for all companies in a given sector)
• And seasonal patterns, which includes historical trends and tendencies
The point here is that you can get better results simply by looking at the same information in a variety of different ways. New information added to the equation changes the picture, sometimes dramatically, and that can help improve your chances of success!


Countertrend Trading

The essence of countertrend trading is entering into a position in anticipation of a reversal, which is a strategy that works best when applied to large cap stocks, commodities, and indices. It’s not recommended for traders dealing with smaller companies, because in general, when a small company’s stock enters a trend, they can last for an extended period of time.
Big companies don’t offer as many surprises or sudden reversals of fortune like smaller companies do, and because of that, when a large company’s stock price begins trending one way, and approaches resistance or support levels, you know that there’s a very high probability that things will reverse course (unless you have other information that supports the possibility of a breakout).


The Donchian Channel – Tracking Extremes

Markets are chaotic systems. That’s why even the world’s best traders don’t profit from the majority of their trades.
Even chaotic systems though, obey certain rules most of the time. Markets can’t exist at extremes, so for instance, if a market suffers a significant drop, then odds are excellent that it will reverse course in relatively short order as traders begin taking advantage of the suddenly more attractive prices on offer.
A Donchian channel is used to determine the overall volatility of any given market. All you need to calculate it are the highest and lowest points in the data for the last “X” number of days. The channel is bound at the top by the highest points, and at the bottom by the lowest.
If the current price breaks out of the top, that’s a good long position entry. If the price breaks out on the downside of the channel, that’s a good short position entry point.
So how good and useful is this? Well, earlier, we mentioned a group called “The Turtles.” This was the exact indicator they used to trade commodities and make millions, in the 1980’s. In particular, they looked alternately at a 55-day or a 22-day Donchian channel breakout to identify opportunities.


Turtle Power!

Here’s an interesting variant on the Turtles’ idea, but this time, applied to large cap stocks, rather than commodities. Basically, we’re going to flip the script, and do exactly the opposite of what that group did. In other words, trade countertrend.
This variant is devastatingly effective, as you can verify for yourself, via Backtesting. Here’s how:
Look up the top 20 companies on the AUX. Get the relevant data and create a 15-day channel, with a plan to enter a long trade when the share hits a 15-day low. As for exit strategy, use a 4% trailing stop.
The results you will get from this strategy are nothing short of amazing!
Note that there’s more than one way to skin this particular cat, too. You can get similar results if you enter countertrend when you see the market move 3-4x ATR over 10 candles, or when it breaks below the lower Bollinger band, two standard deviations from the average, so again, don’t feel as though you’re locked into just one type of analysis here.


Trading On Trends

As you have seen, countertrading can make you a lot of money with relatively little risk, but trend trading can be just as, if not even more profitable. Think about it: The longer a trend continues, the more money you stand to make!
Of course, as we’ve mentioned, prices never move in a straight line, but in a jagged, saw-toothed pattern, which means that any successful trend-based strategy must take a couple of things into account.
First, it must allow you to correctly identify when the trend begins. Second, it must allow you to hold the line when small reverses occur so you can let your profits run, but exit clean when there’s a significant reversal. That’s the trick.
This strategy can be employed with mid-cap companies, indices, commodities, and currency markets (forex).


MACD & Moving Averages

Moving Averages are perhaps the simplest way to track a trend. This is simply an average of the price over time (X number of days). Any time the price is above the moving average, it’s rising. Any time the price is below the moving average, it’s falling. Simple.
A variation on this basic theme is to use two moving averages, one short term, and one longer term. The same basic thinking still applies though. If the short-term trend is higher than the long term one, the price is rising. When the short-term trend is lower, the price is falling. When the two lines cross, that’s your entry or exit signal.
The one time that moving averages can get you into trouble is when the market is moving sideways. If you see that behavior, then it’s probably the wrong time to deploy this particular strategy. If you try to enter the market when it’s moving sideways, you’ll invariably see a string of losing trades. Not a happy situation!
If you haven’t heard of the MACD, you’re not alone. Outside of investment circles, the term is practically unknown.
What it is, is the distance between the averages. As with the moving average itself, it can cross the trendlines, with the difference being that it provides its signals slightly earlier than just using the moving average itself, and that’s’ what gives you the edge. Your “buy” signal occurs when the MACD crosses above the signal line. Your “sell” signal occurs when it crosses below.


Seasonal Trends

Trading signals is all well and good, but especially where commodities are concerned, there are historical trends that can guide you and help you become more profitable. Simply put, there are certain times of the year when trends are much more likely to occur, so rather than simply trading signals all year long and hoping for the best, why not limit your trades to those periods of time when you know that trends are more likely to occur?
Note that you certainly can make money trading on the signals throughout the course of the calendar year, but if you opt for that approach, you’ll make far more losing trades than winning ones. It’s just that your winners will be significant with proper planning, which will make you net profitable.
You can up your game though, trading when you know trends are most likely to occur, have a higher percentage of winning trades and make a lot more money.
In simplest terms, it works like this: crop-based commodities (soy beans, wheat, etc.) tend to see their prices drop just after harvest. The reason? The harvest itself. Once those crops start coming in, the supply of that commodity increases dramatically, causing the price to drop. The further you get from harvest, the more the price tends to rise over time.
Commodities aren’t the only markets that see seasonal trends. In fact, all markets tend to, to one degree or another. A historical analysis of the AUX revealed that the market typically sees strong bullish periods in April, July, and December, and strong bearish patterns in June, September, and October.
The rest of the months, the market basically goes nowhere (moving sideways).
Of course, there are always years where this does not occur, but these are exceptions. The rule of thumb described above holds true far more often than not.
Put this knowledge together with the MACD, and the basic idea is to take an entry when the MACD crosses its signal line, but ONLY IF the historic seasonal patterns suggest that the market is in a period where trend formation is likely, so you would trade long when the MACD crosses above the line in March or April, trade short if the condition is met in May or June, then long again in July and August, and short again in September or October, and long again in December.
As we said earlier though, you may not see an appropriate signal at all, in any given month, and if you don’t, it’s fine – it just means that there’s no viable opportunity present. Just keep a watchful eye out for when you do!
Regarding exits when pursuing this strategy, when the MACD crosses back the other way. Your stop is placed slightly above (or below, as appropriate) such that you’ll exit the trade before the market moves strongly against you.


Trend Trading

Mid-cap companies are those that have firmly established themselves in the market, but are not industry leaders. Prospects for growth in such companies tends to be quite strong as these companies aren’t juggernauts which find growth difficult but have extreme longevity and durability.
Based on these traits, mid-cap companies are ideal candidates for trend-based trading, and you can identify viable candidates by studying fundamental data.

Current Price?

The first thing to look at is the company’s stock price, and the first question you should ask yourself is: Is the company under or overvalued at its current price?
The fastest way to find your answer is to look at the price to earnings ratio (PE for short). To get this value, simply divide the current price by the profits the company is generated. That gives you Earnings Per Share (EPS). A ratio of 6-7 is cheap. A ratio of 20+ is expensive. Good trading opportunities can be found in companies with a PE ratio of 12 or less.
We’ll have more to say about equity (and specifically a company’s return on equity) in just a bit, and it’s another important data point to consider before pulling the trigger on a trade.


How Liquid Is It?

Some mid-cap companies just don’t get a lot of play. They just don’t have much in the way of trading volume. That means that if you enter a position, you may find yourself with a shortage of buyers when it comes time to sell, and that matters because when your signals tell you it’s time to exit a trade, you need to know that you can do that.
A good rule of thumb here is to look for companies that have an average daily trading volume of at least $2 million. At that level, unless you’re holding extremely large positions, you should have no difficulty exiting a trade.


Return on Equity is essentially a measure of how efficiently and effectively a company uses the resources it has. Over the long term, a company’s share price tends to rise at something close to the same rate as the ROE. In terms of identifying investment opportunities, look for companies with at least a 15% ROE.


How Much Debt?

This is a critical bit of information you can glean from a company’s annual statements. There’s no magic number here, but you should understand that the more debt a company holds, regardless of its ROE, the greater the potential risk to you, as an investor.
Your ideal target company will have an ROE of at least 15% and relatively little outstanding debt. A company’s debt to equity ratio is the measure you want to look at here, and a good rule of thumb is a ratio of 70% or less.

Entry & Exit Points

So, let’s sum up. If you find a mid-cap company that:
• Sees at least $2million a day in average trading volume
• Has at least a 15% ROE
• A debt to equity ratio of 70% or less (the lower the better!)
• And a price to earnings ratio of 12 or less (the lower the better!)
Then you have found a viable trading opportunity! To determine your entry and exit points, use your trend analysis and the MACD, exactly as described above, only applied to the share price of the company you’re interested in. That’s it. That’s all there is to it!

Breakout Trading

Breakout trading is best conducted with small cap companies. As the name implies, these companies tend to be quite small, not well established in their respective industries, and prone to sudden, rapid changes of fortune.
A small company might develop the next big whiz-bang distraction and suddenly become worth a billion dollars overnight. Or, it might run out of money before it accomplishes anything of note, and simply disappear beneath the waves.
When a small company breaks out, you’ll see that reflected in its stock price, IF you know what you’re looking for. The secret to that is in studying chart data. It should be noted, however, that chart patterns are highly subjective, although the ability to chart patterns with a computer has removed much of this subjectivity in recent years. Even so, it’s something to bear in mind.


Size Matters

We’ve talked about average daily trading volume before, and when we mentioned it earlier, we mentioned it in the context of ensuring liquidity. That is to say, ensuring that the company in question had enough trading volume that you’d have no difficulty finding buyers or sellers when it was time to exit your position.
That still matters here, but the reality is that small cap companies with high daily trading volumes tend to perform poorly, and most will wind up losing you money. You want a company that doesn’t have a tremendous amount of daily trading activity, but not so little that you’ll have trouble exiting the position. Here, a good target is $1 million a day or more.
In terms of stock price, using historic data as a guide, the sweet spot seems to be shares that trade at or below $6 a share. Breakouts are not only more likely to occur here, but are also much easier to spot. While you’ll occasionally spot opportunities priced higher than this, they tend to have a much lower win percentage and won’t make you as much money.
Having said that, the lower the share price is, the harder it is (in general) to find buyers and sellers when you’re ready to exit your position, so it’s a bit of a balancing act.

Some Patterns Are Better Than Others

Broadly speaking, chart patterns can be divided into three categories:
• Triangles
• Parallel
• And Broadening
There are some other patterns that don’t fall neatly into these categories, but these are the basics, so that’s what we’ll focus on here.

Triangle patterns consist of the classic patterns known as:
• Ascending (a flat top line, and an upward sloping lower line)
• Descending (a downward sloping top line and a flat lower line)
• Symmetrical (an upper line that slopes downward and a lower line that slopes upward)
• Ascending Wedges (both lines slope upward and converge)
• And Descending Wedges (both lines slope downward and converge)
All of these patterns are created by a period of consolidation which is characterized by decreasing volatility. The amount of fluctuation decreases as the pattern approaches the tip of the triangle.

Parallel patterns are a small family where the lines containing the price action are virtually parallel, which makes them markedly different from triangle or broadening formations because the two boundary lines don’t converge to a point at the start or the end of the pattern.
There are three patterns that can be classified as parallel:
• A rectangle (horizontal pattern)
• A channel up (rising pattern)
• And a channel down (falling pattern)

While the share price may be moving sideways, rising or falling, the range of fluctuation remains fairly consistent.

Broadening patterns occur because of increasing volatility in the underlying share, and a breakout of these patterns can indicate a strong move in the share price.
The set of broadening formations is the equivalent of triangles, consisting of:
• Broadening ascending (a top line that slopes upward, with a lower line that is flat)
• Broadening descending (a top line that is flat, and a lower line that slopes downward)
• Broadening formation
• Broadening wedge up
• And Broadening wedge down

As to which types of chart patterns have historically been the most profitable, they are as follows:
• Ascending Triangles, Symmetrical Triangles, and Rectangles can all be traded profitably when the breakout occurs on the upside.
• Broadening Descending and Broadening Ascending patterns can also be profitable when trading long, using a 3% stop loss.

Where short trading is concerned, you’ll find your most profitable chart patterns to be the descending triangle and broadening ascending patterns.

If both the market and sector are falling, then the symmetrical tringle, ascending triangle and rectangle can also be traded short with success, and descending triangles and broadening ascending patterns are even better in falling markets.

We’ve talked about how important independent variables are in previous sections, and this is a quick summation of the other variables you can factor into your analysis to help improve your odds. For long trades, look for the following opportunities and market conditions:
• Sector in an uptrend
• Market in an uptrend
• Share price between $0.20 and $6.00
• Average daily trading volume between $1 million and $10 million
• Volume in the up legs is higher than volume in the down legs of the pattern
• Look for the following chart patterns: Ascending Triangle, Symmetrical Triangle, or Rectangle

Find an opportunity like that and you stand an excellent chance of success, because lots of outside variables are trending the same way you’re predicting the price to move.

For short trades, the following is your recipe for success:
• Sector in a downtrend
• Market in a downtrend
• Share price between $0.20 and $6.00
• Average daily trading volume between $1 million and $10 million
• Volume in the down legs is higher than volume in the up legs
• Look for the following chart patterns: Descending Triangle or a Broadening Ascending pattern
In either case (short or long) use a stop loss of 3% to exit.


Pairs Trading

This is not just an interesting concept, but it’s “market neutral,” meaning that it is immaterial whether the market is currently rising or falling. It’s a nice, low-risk strategy that sees you trading two highly similar CFDs that tend to move in a similar fashion, such as share CFDs of two companies in the same sector, or highly similar commodities such as gold and silver.
If the price of one goes up, then it’s highly likely that the price of the other will too. If the price of one goes down, again, it’s extremely likely that the price of the other will drop as well. Sometimes though, the stocks move away from their normal behavior, and that’s what creates the trading opportunity.
To enter into a pairs trade, create two equally sized positions, one for each asset in the pair (company, commodity, or whathaveyou). You’ll be buying shares in the company you believe to be undervalued, and selling the position you believe to be overvalued.
How well this works for you depends on your analysis and how well the companies perform relative to each other.
Again, this works whether the market is rising or falling. The single most important point to consider is that the two assets tend to move the say way over time.
Some charting software will plot pairs for you, which is quite handy, but you can create it yourself simply by dividing one company’s share price by the other. The exact value of the ratio doesn’t really matter. What you’re more interested in is the change to this ratio over time, particularly when prices reach an extreme, based on historical data.
Figuring out where to place stop orders can be tricky with this strategy, because you can make money if both assets move higher or lower, which means that a stop could hit while you’re making money.
In order to manage your risk, simply monitor the change in profit or loss on the position and exit when the loss hits your max risk level. Because you’ve got a trade on both the long and short sides, these trades don’t tend to fluctuate much on a day to day basis, which simplifies things from a management perspective.


Dividend Trading

This is an interesting trading approach. It’s a rare trader who buys CFDs specifically to capture dividends, but you can certainly do it, and it’s a viable strategy when well-executed. After all, if you buy a CFD on a share that pays a dividend, you already know the company in question is profitable.
One of the first questions you’ll want to ask if you’re looking at a company that pays a dividend is “what’s the yield?”
To arrive at the answer, you simply take the share price, divided by the dividend paid, which is typically quoted as some number of cents per share. So for example, if a company pays a fifty cent dividend and is trading at $10 a share, then the dividend yield is 20%. That’s exceptionally high, but you get the idea.
On the Australian market, you’ll find that dividends tend to range from 0-10%, with the average being around 3.5%. Also note that companies that pay dividends on the Australian market pay then twice a year, with the first payment being called the interim dividend, and the final one, which follows the company’s annual report, being referred to as the final dividend.
Note that companies are certainly not required to pay a dividend, even if they turn a profit. The board of directors may decide that they need to retain those profits in order to facilitate further growth, so it’s not a sure thing, by any means.
When trading dividends, the most important date you need to know and remember is the ex-dividend date, which is the date that you normally receive a dividend payment.
So what happens to a company’s share price on or around the ex-dividend date? If you look at the historic data, you’ll find that the share price tends to climb in the days immediately preceding the dividend announcement, then drops by the amount of the dividend on the ex-dividend date.
A novice trader might think that there’s an opportunity to sell short in the days just before the dividend is announced, then reap a nice profit on the other side, but it’s not that easy. Remember, if you’re holding a short position when the dividend is announced, then the dividend amount will be debited from your account, which will wipe out any potential profits you may have realized.
Having said that, there is an opportunity here, provided that the broader market is not falling.
To take advantage of the opportunity, you’ll want to find a company paying at least a 3% dividend yield and an average daily trading volume of at least $10 million.
The idea is that you’ll enter your position when the share price drops any time during the two weeks leading up to the ex-dividend date. You’ll want to place a stop at the most recent low on the position, then hold it until it either hits a stop loss, or exit the position one day before the ex-dividend date.
Because you’ve bought on a down day, and you know that historically, the price rises leading up to the announcement of the dividend, you create an opportunity to profit.


Chapter 8 – Key Points To Remember

• Never underestimate the power of positive thinking. If you believe you’ll succeed, that puts you in the right mindset to actually succeed.
• Having said that, belief isn’t enough. At the end of the day, trading really isn’t about the money, it’s about approaching the market in an organized, systematic way. About doing the things that all successful traders do. Making the right moves.
• At the end of the day, it’s not really about the money, it’s about the game. Money is just the byproduct of implementing a successful strategy.
• Your trading routine should include pre-market preparation, research, market review time, and of course, the time spent actually trading.
• Trading is stressful! Know that and accept it. It’s not something you can change, but you can manage it via good preparation, and a willingness to step away from the computer, take breaks, and by spending time with your friends and family. Also, when you’re first starting out, use low-risk strategies to help reduce stress further.
• Read everything! If you’re not learning, you’re not growing. That’s just as true for trading as it is for anything else. You should constantly be studying the moves of successful traders and keeping in contact with other traders you know to compare notes and share ideas.
• As a rule of thumb, if you’re looking at a large cap company, the optimal approach is to trade them countertrend. For mid-cap companies, look for trends, and seek out breakouts in small cap shares.
• Another rule of thumb: Trade the top 20 shares by entering long positions when the shares reach a 15-day low. Use a 4% trailing stop to exit.
• Pay attention to seasonal patterns when trading indices, currencies and commodities. By studying seasonal patterns, you’ll gain familiarity for when trends are likely to form, and can be on the lookout for them.
• Use analysis of fundamentals to find mid-cap shares to trade.
• The best long trade chart patterns are ascending triangles, descending triangles and rectangles. The best short trade chart patterns are descending triangles and broadening ascending patterns.
• If you are a breakout trader, be sure that the market, sector, and volume indicators all support the breakout before entering into a trade.
• Pairs trading is a low-risk, market neutral way to trade CFDs. By entering one position long and the same size position short in a correlated share, you can profit from the difference in movement between the two shares.


CFD Trading - Glossary of Terms