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Tharp's Thoughts Weekly Newsletter

October 15, 2008 — Issue #394  
  
Hot Off the Press

The Definitive Guide to Position Sizing Is Here!

Article

Volatility Turbo Charges Day Trading Opportunities by D.R. Barton

Workshops

2009 Workshop Schedule 

Trading Tip

Remembering the Big Picture by D.R. Barton, Jr.

Note from Van

Follow-up from Last Week by Van K. Tharp

 

Hot Off the Press

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Feature

Volatility Turbo Charges Day Trading Opportunities

by
D. R. Barton, Jr. 

The two greatest golfers who ever played the game share one trait that stands out above all others. And this probably isn’t the first trait that most folks think about. 

Tiger Woods, by most measures, is already the greatest golfer ever.  If you look at statistics such as career scoring average, wins per tournament entered, tournaments and major tournaments won by a certain age, consecutive cuts made, etc., Tiger is clearly head and shoulders above everyone else. But for total major tournaments won and other career level achievements, Tiger has still not caught the reigning champ, Jack Nicklaus.

When one thinks about these two great golfers and the traits that set them apart, it’s easy to think about mental toughness, clutch putting, and booming drives.

However a different trait sticks out for me: Woods and Nicklaus are both undisputed masters of course management. This means that they always have a great plan in advance of playing, and they know where on the course to be aggressive and where to play conservatively. They know where to take a calculated risk and go for a birdie or eagle, and where to just play smart, take a par, and move on to the next hole.

There are so many good analogies between golf and trading. But this idea of course management is especially useful now, in these insanely volatile markets.

The opportunities for day trading profits have never been greater. And the need for managing risk has never been more apparent.

Let’s take last Thursday (10/9) as an example of the extreme volatility that’s in the markets now. The Dow's movement went like this: from its open it went up 420 points until 10:05 EDT, then down 458 points by 12:35 EDT, back up 435 points by 2:10 EDT, and then dropped 465 points into the close of regular trading hours. 

That’s four moves of 5%... in one day! Take a look at this chart, showing the volatility explosion that has taken place.

Let’s review what’s going on in the day trading world, which has been eating up this nice volatility. Day trading strategies are working really well because the extra volatility brings a greater number of opportunities per day with bigger per trade payoffs.

To give a balanced view of intraday trading, let’s look at both the positives and the negative; however, I think most will agree that the benefits of intraday trading outweigh the downside for traders who are ready to play in that time frame.

The Up Side of Day Trading

Reduced Risk. First and foremost, intraday trading eliminates “overnight gap risk.” This is such a big deal that brokerages give customers who open a stock day trading account twice as much leverage for day trading as for overnight trading. And because we don’t have to factor in overnight gap risk, day traders can use more aggressive position sizing techniques. And the fact that positions are closed at the end of the day leads to the next benefit. 

Sleeping Easy at Night. Day traders don’t have to worry if some news is going to hit after the market closes that blows up a position. I’m sure there are folks out there have had the misfortune of being on the wrong side of overnight news. And in the current market conditions, overnight risk requires extreme caution for anyone who is holding positions overnight. 

Leverage. The reduced risk of day trading allows traders to use 4-to-1 leverage on their trading accounts. By SEC rule, traders must maintain a $25,000 account size to get this leverage rate. Please note that brokerages are not required to give 4-to-1 leverage for day trading accounts. Due to increased intraday volatility, some brokerages have reduced the leverage they are offering clients. Check with your broker or potential broker to see their current policies.

No Margin Interest. Because the extra leverage (or margin) is only used for less than one trading day, no interest is charged for using this extra leverage. Just another added perk for day traders!

Trading Styles for Everyone. One of the things that surprises many people is that most day traders do not trade like they’re playing a video game! Many people comment, when Brad Martin trades live during our day trading workshop, that he’s calm and takes only a select number of trades. Sure there are profitable scalping methods for quicker paced traders. But most of the useable day trading strategies are much more about patience than about speed!

The Down Side of Day Trading

Leverage...the Other Side of the Sword. Great leverage can bring great reward. But it also brings greater risk. Our logical mind will quickly tell us that if we can trade four times the value of our account, we can get bigger gains – but also bigger losses. Proper position sizing is a MUST for day traders.

Overtrading. There is a definite tendency for day traders to take too many trades. Because today’s trading platforms have made it so easy to execute trades, many traders fall into the trap of taking too many low quality trades. The development of a good trading plan and the use of high quality strategies (along with a little discipline) can mitigate this problem area.

Trading Psychology. Because there is the opportunity to trade more often and with higher leverage than in other trading time frames, day trading tests the trader’s psychology exponentially more than any other trading style. As the old saying goes (credited to George Goodman), “If you don’t know who you are, the stock market is an expensive place to find out.”

Trading psychology is so important for day traders that the upcoming course that I teach with Brad Martin has an expanded section on trading psychology that has been developed specifically for day traders. We’d love to have you join us there. Click here for more information.

About D.R. Barton:  A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena.  He is a regularly featured guest on both Report on Business TV, and WTOP News Radio in Washington, D.C., and has been a guest on Bloomberg Radio. His articles have appeared on SmartMoney.com and Financial Advisor magazine. You may contact D.R. at  “drbarton” at “iitm.com”. 

 

Workshops

The 2009 Schedule has been posted! Click here to view. 
West Coast USA and Sydney AU coming soon.

Trading Tip

Remembering the Big Picture

by
D. R. Barton, Jr. 

This past weekend, the Barton family celebrated my Grandmother’s 90th birthday.  A recent inductee into the “Coolest People on the Planet” club, my Grandma Megs drove 30 miles over to my parents house to meet us when we arrived.  What a gracious lady; she’s so full of life and still delighting everyone around her as she enters her tenth decade.  My son and daughter still crave her delicious home-baked macaroni and cheese and those amazing breakfasts with country ham and homemade biscuits.  Ah, but I’m beginning to salivate on the keyboard, so we must move on.

I tell you about visiting Virginia because just when we pulled into the driveway there on Friday afternoon, I got a call from my good friend and market maven Christopher Castroviejo.  As most of you know, the market bottomed on Friday after a furious opening drop and then closed the day strongly.

Christopher chided me over the phone, “Take off your short-term trading hat and tell me what really happened this morning—something technically very significant.”  I’m usually up for a challenge, but I had to reply, “I don’t really know, Christopher…I was sailing down the Shenandoah Valley, dodging 18-wheelers.”

Christopher paused for dramatic effect and then let the cat out of the bag, “We traded to within 1POINT of a 50% Fibonacci retracement for the whole 1982 – 2007 bull market.  It helps to keep a little market history in perspective.”

So that you can see visually what Christopher was talking about, take a look at the Fibonacci retracement lines drawn on a monthly chart.

Indeed, the low for this move was within a single point of the 50% retracement.

And I have to say, Christopher was feeling pretty good about that Friday turnaround, because on a Thursday evening (10/9) conference call for a group of our clients, Christopher made a bold prediction that within the next three trading days we would see the biggest up day of our lifetimes.

Lo and behold, Monday (10/13) was the biggest single point move up ever, and the biggest percentage rise in the U.S. markets since 1933.  So I guess he had a real reason to crow!  (Of course he didn’t know that when he was giving me his little history quiz on Friday…).

So even though we have historical volatility and unprecedented financial news happening almost daily, it’s still wise to keep an eye on the history of the markets and on the bigger picture for clues as to what’s most likely to happen next.

Great Trading,
D. R.

 

Message from Dr. Tharp

Follow-up from Dr. Tharp

Last week in my article, The Fate of the "Average" Investor, I gave everyone a check list of 13 questions to ask to determine if your financial health is in danger. If you missed last week's article, click here.

All the best,
Van

P.S. Melita's Inspirational Corner will be back next week. 

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Copyright 2008 the International Institute of Trading Mastery, Inc.

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"History never looks like history when you are living through it." ~John W. Gardner

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