Thursday, July 05, 2007

Being Long and Short - an example

I received the following comment on my previous post, which I consider so important for understanding the new technique, that I copied it and post it as a new article:

It still comes down to eventually one thing, sooner or later you have to make up your mind, do you want to be long or do you want to be short..the only effective thing you have accomplished is doubling or tripling your commission cost...Peaktrade 

You might be right with the commissions, but I'm actually not convinced (yet). Meaning it might be something I need to learn (aka pay the market for) myself.

As I see it right now, the oil market  (as every market) is going from trending to ranging periods and back.
What distinguishes the oil markets from other markets is that the range periods usually show healthy 30 to 50 tick ranges, which can be traded on the long and short side. With the technique I'm proposing I'm effectively lowering say the entry for a (temporarily) wrong long entry to the or near the bottom of the new range. Let's explain that with an example:


I take a Breakout Long signal CL 71.50, but CL is not going up, instead it's rejecting the highs and trades to the downside.

So I go Short WTI 71.30. I'm now down 20 on the Long. Now any further loss in CL is matched with an equal gain in WTI.

For this example's sake let's assume CL really switches into trend down mode and finds a new bottom around 70. I see 70 holding and cover the WTI short at 70.10.

That makes a profit of 120 on the Short side, while my first Long is down 140. On balance that means I've lowered my Long entry from 71.50 to 70.30.

Now let's say CL makes a double bottom at the round number and I add later at 70.10 on a new long signal. Now my average entry for the 2 contracts is 70.20 instead of 70.80, which it would be had I not taken the WTI short.

Let's look at the example the other way: CL trades down to 71.30 on a fake move and jumps up to test the 72.00 area. Again I'm short WTI 71.30 and Long CL 71.50. Instead of a profit of 50 ticks I'm down on balance 20 ticks, as CL shows me a profit of 50 ticks while WTI is down 70 ticks. I see 72.00 breaking, but prices are not able to go beyond 72.10. So I exit my CL long at 72.00 for a profit of 50 ticks. Now I'm short WTI on balance 71.80 (71.30 +50 ticks = 71.80). 72.00 is really holding and prices make a double top, giving me a new independant short signal at 71.90. Now I'm short WTI 71.85 instead of 71.60 which my average would be had I not stayed in the CL long.

Of course I could have exited the WTI short the moment I saw, that it was a fake, but at my current stage as a trade I'm often not quick enough to decide that. So all I would accomplish would be accumulate losses by multiple Stops ( CL long 71.50 stopped at 71.30 and reversed short, Short stopped at 71.50 and reversed long for already -40 ticks).

As I see it my technique might produce more commissions, but it buys me a lot of time and avoids stops which otherwise I would have to take.

5 comments:

Anonymous said...

I think your last sentence sums it up. You want to avoid taking stops you would otherwise need to take. It is natural to want to avoid being proven wrong, I know the feeling myself very well.

One day when the market trades down to your stop in WTI and you want to hedge yourself in CL - you will put in a limit order, only to remain unfilled as the market continues to move against you. What then ?

One day you will hedge yourself as one contract looks cheap against the other, only to see the spread to move against you, as the commercial players know something that you don't. What then ?

One day you will have positions in both markets and you will close the one in profit, while the market continues to trend and have your other position accumulate even larger losses (Reminiscences of a Stock Operator anyone ?). What then ?

All of the above have happened to me one time in the past. Hope you have worked out a trading plan when the market behaves "unexpectadly"...

T.K.

Globetrader said...

TK,
I have my largest losses when the market behaves unexpectedly. I have to admit that and I usually take the experience, learn from it and see what I can do to prepare for it the next time. Fortunatly these unexpected, erratic movements have become less often. But sure they happen and all I can do is being prepared, having a plan.

Now I'm often writing about avoiding stops, I know that. I once read an article about "The death of a 1000nd stops" (I might even have mentioned the article last year in this blog actually)
and I totally agree with it. Being forced to take small stops one after the other drains my account as fast as one big stop can, but it also drains me emotionally, rendering me unable to continue trading effectively.
I'm a regular reader of Phil Flynn's energy report (http://www.traderslog.com/forum/forumdisplay.php?f=42) and at the end of his blog he usually posts the positions he is in or intends to take for his fund.
I tell you I like a line like that:
We're long August crude from apprx 70.00 - raise stop to 69.00
He is trailing his stop 100 ticks below his entry, adjusting it as the market moves up. I know a few other traders who can afford trading the big swings in the market and ignoring all the noise. I can't as for me a 100 tick stop would mean a big blow to my account. On the other hand I see the big swings and like to trade them. So I'm looking for ways to enter the big swings with controlled risk. That's why I'm looking for ways to get me in the market at the right price without getting chopped to death in a volatile market.

I'm glad reading comments like yours or others like the ones from Gary, which point to the weaknesses in my arguments. I need to be aware of them before I decide to go a certain way. It's really the reason which keeps me going on writing this blog.
I appreciate any well meant comment here, we can all learn from each other and I hope I will never be so arrogant to say, that I'm not interested in the opinion of another trader.

Anonymous said...

You could take this one step further and instead of closing a position you open the opposite position on the same contract, especially in markets moving very fast against your original position. In effect you freeze your original position at a specific price(some might consider this equals to a stop). I don't know how the trading rules are explained in Germany but here in Belgium they don't allow you to do that with one and the same broker. You can always open a account with another broker to open the opposite position. I draws down your trading possibilities since you have to fund two accounts. I know it makes no sense money wise but it can made all the difference on a psychological level.

Gary said...

I understand your reasoning for the lower margin requirments..practical...BUT..again if you have and 80 tick loss in the WTI and an 80 tick profit in the CL you have successfully completed a masturbatory exercise...you are STILL at ground zero and you have to make up your mind which position you want to "leg" out of...the loser first, and hope the profitable leg gets more profitable, or the profitable one first and hope the loser becomes "less" of a loser...I still can't figure out for the life of me what you have accomplished other then increasing your commission costs...and the algorithm programs are going to leave your hopes in shreds when you make the "legging" decisions...I think you might be better off looking for spread opportunities in the Brent (COIL) against the CL or WTI...West Texas Intermediate crude is becoming less and less the preferred crude versus Brent and Dubai delivery grades (look at the discount of WTI, CL to these grades)...I traded 151 contracts of CL yesterday and lost about $500 on the trades and $600 on the commissions...not bad considering...SO...the name of the game is figuring out the algorithm counts and HOW to take ADVANTAGE of the "voids" and "vacuums" these programs create...its almost like when you get long and there is a 30 point down riffle, you should buy MORE, but then you are opening yourself to the type of nightmare you had not long ago when you sweated a 180 tick down overnite...play with tight 8 and 13 tick stops and you are going to end up wheeling 151 "cars" like I did yesterday...quite an interesting new game, take it from a trader that made his first trade in Chicago in 1965...BUT it is a NEW game and methinks old patterns and old "setups" are relics of the past...so lets figure it out...great blog...Peaktrade

John Forman said...

My concern is that you are either trading the wrong market here, or that you are undercapitalized for the types of trades you want to make. Your comment about the 100 point stops being too large for you and the frequency of smaller stops getting hit is what I'm going off of here.

A great, great many traders think that smaller stops mean less risk. That's just not true. Tighter stops actually increase the risk because they're more likely to get hit through the course of normal price volatility.

You shouldn't think of your stop as being a "stop loss". It should be the point at which you get out of a position because it's no longer doing what was expected.