Scott Pluschau is a Contributing Editor to the ETF Digest.
Let’s take a look at the Silver Exchange Traded Fund symbol SLV again. It was back on May 5th, 2011, that I did a write-up on SLV that can be found here:
I mentioned at that time that markets rarely make V-tops and there is a good probability that once we have a new balance area form in the intermediate term time frame and it can breakout to the upside the highs will be tested again.
I also felt at that time that there would likely be minor support in the $33-35 area and that since Silver was in vertical development (strong bull market trend) in the weekly time frame, that a new consolidation area would likely be forming sooner then it retracing all the way back to the prior balance area where it would likely have found major support. This market to me looks healthy in the big picture. I have marked these consolidations or as I call them from an Auction Market Perspective “Balance Areas” with blue rectangles. It is in the weekly time frame, that the market has currently found value in my opinion. The price action inside this current balance area is likely to resemble randomness or noise. I want to avoid that at all costs.
I have no interest in buying silver or selling silver in the intermediate term time frame and from a technical standpoint unless it is at the extremes of this balance area. If I had to sell silver it would either be on the next rally toward the top of this balance area or on a breakdown from this balance area.
Let’s take one more look at the chart again and imagine that this is an intraday chart with five minute bars rather than a weekly chart? Auction market principles can be applied to all markets in all time frames. Would you be looking to sell here if you were a day trader? I know I wouldn’t. I would be looking to buy at the appropriate entry or be adding to my position; otherwise I would be stepping aside. My bias is to the long side until the price has broken down from this balance area. A rally back to the balance area after a breakdown would then become a low risk short trade for me.
Right now I am looking to for a low risk entry to buy on a reversal from the extreme lows of this balance area, (approximately $32.50), and I will be adding to it on a breakout to the upside (approximately $38), and will then be targeting the highs of approximately $50.00. These are forgiving trade locations, because I can set a reasonable stop loss. First we have to get a bounce off of the extreme lows of the balance area and then my stop loss will be placed comfortably beneath it. The reward to risk is favorable. I don’t mind losing here. I can get stopped out and think nothing of it. On a breakout of the balance area to the upside, my next stop will be placed half way inside the balance area. Breakouts from balance areas should not retrace much, and I will take this loss without blinking an eye. Losses are a cost of doing business. This is the type of trade where we could be wrong multiple times, and be right once, and be very profitable. Who knows where silver may go making a new high above $50? Besides having the discipline to follow through with the trade plan it is important to also have the correct position sizing.
Let me touch on money management briefly to give you an idea what I mean. I am only scratching the surface. Let’s say we have a trading system that gives us 50% winning trades, and you risk 10% of your account on each trade. The law of averages says that if you flip a coin enough times (50% probability), you will come out heads or tails 10 times in a row at some point. If you risk 10% of your account on every trade, and you have ten losers in a row, what are the ramifications? Even though you may have a valid trading system (50% winners is incredible), you could still destroy your account. Trading over the long term is about positive expectancy. It is why I would rather have a trading system which gives me only 35% winning trades and is very profitable, than have a trading system with 80% winning trades and lose money. Believe me, you can have a trading system with 80% winning trades and lose money, because it is all about how much you risk on each trade compared to the profits you make, which comes along with those probabilities, which will determine whether or not you are successful in the long run. Any trading system that has 80% winning trades is taking profits very quickly. The formula for success is to cut your losses quickly and let your winners ride, not the other way around.
One psychological “trading” issue we may all have is from growing up and going to school. Anything below 70% correct on an exam is a bad grade. So we are trained to want to be correct most of the time (never mind the issues with our ego), and therefore I believe traders want to be right most of the time when they buy or sell, and unfortunately that may be a fatal flaw. An overwhelming majority of traders lose, those are the facts. The focus should be on positive expectancy to the trading system, which means high reward to risk, and staying in the game with proper money management techniques, rather than focusing on a high percentage of winning trades.
This is Scott Pluschau for ETFDigest.com
Comments are welcome at firstname.lastname@example.org