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Trading Framework & Strategy

 

Trading is all about decisions. Just like a Formula 1 racer maneuvering a chicane (sharp double bend) or a Poker professional playing a hand, a trader makes at least 8-10 decisions on the go on every trade. It is a constant battle between the impulsive & the deliberative mind. Without a framework & strategy, it is easy to lose focus and let our emotions & biases prevail.

You can’t depend on your eyes when your imagination is out of focus” - Mark Twain

FRAMEWORK:

The first step in arriving at a decision is to approach it with a framework.

An app developer needs code libraries, compilers, general functionalities as a framework; a project manager uses scrum, lean, waterfall structures; a formula 1 racing team depends on reinforcement learning [RL]. Similarly, a trader should also operate with a framework.

Elliott waves & Fibonacci (Fibs), when used as a combination, provides an excellent framework & structure.

In simple terms, this combination works like a GPS in a map. Among the plethora of potential routes available in a map, the wave patterns narrow it down to a couple of potential paths. Wave counts within a structure (3/5 patterns) along with the nature of the wave (smooth, irregular etc) reveal & confirm the 'higher probability' route. Fibs within this wave structure provide clarity on where to enter, how far to go on the path & where to exit to get to the planned destination. 

When this framework is applied to markets, it yields a 'low risk, high probability path' along with key supports & key resistances (entry/exit points) within this path.

Our team analyses the markets round the clock by implementing this framework to provide potential technical paths/trends along with its respective key support & resistance levels.

STRATEGY:

One of the most important steps in becoming a good trader is a reflection process with the objective to determine a sustainable strategy that is a fitment for one's emotional mind since every individual is wired differently. Three strategies - all with unique pros & cons make the super-set of choices that are available. One has to reflect & evaluate a strategy that suits them best.

A] POSITIONAL: Longer term trades with a window of few weeks to months. Operating with a "let your profits run" mindset.

  • Wait for an important signal in a larger degree (macro-level) pattern that will swing the probabilities towards a shift in the macro-trend. 

  • Once the signal is confirmed, wait for the price action to approach a key level [In a bearish setup - wait for a bounce to a key resistance. In a bullish setup - wait for a dip to a key support]

  • Execute a trade at the key level with a stop loss near it. Risk should be a tiny percentage of the overall trading equity by adjusting the position size.

  • As the trade moves in the direction of gains, consider adding at newer key levels to scale up the position.

  • Start moving or trailing stop losses near newly formed key levels to reduce the risk to zero & to protect gains 

PROS:

  • Excellent risk/reward ratio if the entire macro-trend plays out without any disruption

  • Limited monitoring of positions, especially after the trade moves substantially in the direction of gains. Works well for busy professionals.

  • Lower brokerage fees, if a good discounted broker who charges a flat fee for longer term trades can be identified

CONS:

  • Market moves take time. Strategy requires a strong stomach & an ability to control emotions during wild smaller degree moves. ‘Sitting tight’ & patience remains the key.

  • In an uncertain & unstable environment, changing fundamentals may shift or reverse the macro-path frequently risking previous gains

  • High overnight holding fees or swap charges by brokers can shave off a significant portion of gains. Identifying a discounted broker, preferably with flat fee structure, is the key.

  • Rollover of future contracts can result in losses if futures are in a contango

  • Opportunity cost: Capital deployed in this strategy will be occupied & cannot be utilized on other potential trade opportunities. 

  • Frequent weekend exposure. Any unexpected fundamental development over a weekend has the potential to create large gaps in price action on Monday.

 

B] SWING: Shorter term trades with a window of 3-5 days. Operating with a "let your profits run ONLY until the next hurdle" mindset.

  • Operate in the direction of the larger degree trend

  • Execute a position at the key level with a stop loss near it. Risk should be a tiny percentage of the overall trading equity by adjusting the position size.

  • As the trade moves in the direction of decent gains, move stop loss to cost (entry price) to reduce the risk to zero.  

  • Continuously monitor & trail stop loss to protect gains 

  • Book gains near the next key level

  • Avoid weekend exposure

PROS:

  • Accumulates smaller gains frequently and quickly builds equity

  • Most optimal trading strategy in an uncertain & unstable environment.

  • Extremely limited impact from swap brokerage fees or rollovers

  • Peace of mind during weekend with no exposure to breaking news that has the potential to influence a gap open on Mondays

  • Excellent cash flow & liquidity in the trading account 

CONS:

  • Frequent monitoring of positions

  • Smaller degree whipsaws because of reports/news, may, sometimes, result in reduced gains or trigger stop losses. Ability to handle such scenarios remains the key.

  • Needs strong control over emotions to not trade every candle, which can lead to over trading followed by revenge trading

 

C] SCALPING: Ultra-short-term trades with a window of few hours to 1-2 days. Operating with a "focus on immediate profits" mindset.  

  • Operate at most key levels, irrespective of the larger degree trend

  • Focus on a "stipulated" number of points as a target in each trade irrespective of whether the trade hits the next key level  [Example: 50 points in an oil trade or $20-25 in a gold trade]

  • Intentionally exits the trade pre-maturely as soon as the specific target is met with strict discipline

  • Strategy heavily depends on the arithmetic of risk/reward ratio, number of trades & win ratio to build returns. For example: 4 trades per week each with a risk/reward of only 1:2 & win ratio of only 50% shall yield an excellent annual return of ~100%.

 PROS:

  • Focuses only on the current smaller degree trend without worrying about the larger picture

  • Mechanical process that can be effective with exceptional discipline & solid risk management

 CONS:

  • Very easy for the impulsive human mind to get into the habit of over-trading & revenge trading

  • Eyes on the markets & economic events calendar all the time

  • Smaller degree whipsaws can erase gains frequently 

  • Without proper position sizing & stop loss management, risk can be large

                                                                                               

Once a framework is trusted upon, the trader needs to FOCUS on the most optimal strategy that is compatible with their impulsive & deliberative emotions. Operating with multiple frameworks or strategies simultaneously is not a good idea & is akin to a formula 1 racer participating in off-road racing, drag racing, stock car racing simultaneously OR a cricket player seeking to perform well in all formats at the same time (Tests, One day & T20s). 

 

FRAMEWORK & FOCUS is the FIRST STEP to building a sustainable & healthy trading account.

 

"It is literally true that millions come easier to a trader after he knows how to trade, than hundreds did in the days of his ignorance” - Jesse Livermore

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