What is the Success Rate of Day Trading?

All too often you will see day traders brag about their successful trades. Meanwhile they often end up sweeping the less successful ones under the rug. Therefore, it is difficult to determine the real success rate of day trading. However, some market experts believe the rate could be as low as 10%. Others suggest it may be nearer 30%. Although we do not know for sure, it’s same to assume that the final figure is somewhere within that range.

There is, however, one thing we know for sure. Many day traders find it difficult to stick to their trading plans after going live. They tend not to manage risk with their head but instead they are guided by their heart and “gut feelings”. So how do you fix this? 

To be successful, you need to work out your investment strategy. Stick to your stop-loss limits and know when to bank a profit. In effect, run your winners, cut your losers. This will help ensure that you keep your discipline. Just because other day traders follow like sheep doesn’t mean you need to do so as well. Do your own research and if the trade lines-up correctly, then do it. If it doesn’t, walk away. Sounds simple on paper.

The key to day trading success is discipline. Stick to your strategy and if you hit your limits, then deal with it. Uncertainty, confusion, fear, and greed are the worst enemies of day traders.

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Why do Day Traders Fail?

While many people look for a catch-all solution to improve their day trading, there is no simple fix. In reality, it is a mixture of mistakes that you need to address separately. It often down to a lack of focus, a burning desire to prove the market wrong. While many traders know what they want to do, the final push still requires extra confidence. Over the next few sections, we will cover some of the main reasons why day traders might fail. Keep in mind that none of these mistakes are unavoidable. Especially if you stick to your strategy. However, before we move on, let’s see if we can learn a lesson or two from some famous/notorious traders.

One example is George Soros, the man who broke on the Bank of England and made a one billion dollar profit. Another one is the infamous Gordon Gecko, the cutthroat character from Wall Street. They’re famous for making a living off their winning trades, but what about their losses? In reality, it is impossible to be profitable with each and every trade. Markets move, unexpected news emerges and you simply can’t have your finger on the pulse 24/7. It’s impossible to make the right call every time. However, if you are able to cut your losses and run your winners you will see a huge difference. Your overall returns are bound to increase.

What seems too high and risky to the majority generally goes higher, and what seems low and cheap generally goes lower.”

– William O’Neil

In the market, cooler heads prevail. Work on your analysis instead of just hoping for the best and you will get more trades right than you get wrong. That should be the basis of your trading.

Without the bad days, you can’t enjoy the good days, learn from your mistakes, have confidence in yourself, and go for it.

Not Using a Stop-loss Orders

In theory, every new trader will have a stop-loss strategy in mind. It is one of the best means of protecting their profits and cutting their losses. Why is it that so many traders who switch from back trading or forward trading to trading live seem to struggle with stop-loss limits? The reason is simple. It feels unnatural to sell a futures contract or equity when it is going down. That is especially true if you are protecting a profit after moving your stop-loss limit higher in the past. That final push of the button, fighting that thought that you could have made a few extra dollars by selling higher up, it just doesn’t sit well. It feels well, wrong, and many traders crack under the pressure even when they know they should hold on a little longer.

Example

Imagine the following. You have called the S&P 500 E-mini Futures Contracts correctly, and you are sitting on a very healthy profit. In your mind, you’re already trying to spend that money. What can I buy next, how should I spend the profit, should I treat myself to something? That kind of thinking is a mistake. The gains you made on paper is just that until you sell your investment and realize the earnings. Then all of a sudden, the market starts to drift. The S&P 500 E-mini Futures Contract is falling in price, and you are slowly but surely approaching breakeven. In the back of your mind, your thoughts are simple, I got the market right once before, and I will get it right again. Hang in there, it will come turn around..

As the contract slips further down, you move from profit to breakeven to a small loss. You might think if only I had sold higher up! Maybe you feel it is wrong to sell the contract for a loss. You might still hope that the market will pick up. Once the contract price passes your stop-loss limit, you’re in no man’s land. You don’t know which way to turn, and you don’t know what to do. Slowly but surely, the pressure begins to mount. The margin calls come in, and you grow more nervous. This scenario is all too familiar to many traders.

How to Avoid this Problem

The key to stop-loss limits is to do them. Just do them without a second thought. Once they hit your limit, that trade is gone, and you are now looking forward to the next one. Those in the position of moving their stop-loss limit higher and higher as the contract price goes the right way should, at worst, still make a decent profit. At best, they will see the value of their contracts continue to go the right way. Yes, once the market turns and your futures contract follows suit, you will be selling on the way down. You will have missed a little bit of profit, but you will pocket your gains and live to fight another day. 

Whether you are using a rising stop-loss limit to protect your profit or avoid taking a loss, if the price of your futures contracts hits your stop-loss limit, hit the button, hit it hard, and don’t think twice.

Not Managing Risk Well

The thing about risk is that without it, how can you expect a return? The risk/reward ratio is what drives traders. It dictates their profits and losses and lets them challenge the market. If there were zero risks in buying an equity or futures contract, then there would be no upsides either. This is because, in theory, all of the news and expectations going forward would already be part of the share price.

Therefore, when you are looking to acquire equities, mutual funds or the ever popular S&P 500 E-mini Futures Contracts you need to appreciate risk and manage it. How much risk are you prepared to take? Is the upside worth the potential risk you take on the downside? Would you flinch at the first tick upwards/downwards and lose your cool? When you take out all of the surround noise regarding investments it comes down to one simple formula, the risk/reward ratio. If you can’t handle risk then you won’t get the rewards.

All investments carry risk. Without risk, there is no reward. Balance the risk/reward ratio and work out whether it’s time to invest. To be successful, you will need to learn to manage risk, embrace it, and use it to your advantage.

Not having a Trading Plan

Investing in futures, equities, or exchange-traded funds without a trading plan is like jumping in your car, driving off the road, and just going forward. Where are you going? How will you know when you get there? What exactly are you hoping for? 

There are a wide array of strategies to build your trading plan around, These can include moving averages, stop-loss limits, Fibonacci retracement and price action trading, to name but a few. Each one of these strategies offers a different attitude to risk, a different risk/reward ratio and gives you vision, focus, direction and a destination. The summary of these factors is what will make up most of your trading plan. You may be using a stop-loss, which you can revise upwards as your investment increases in value. In order to be successful as a day trader you should view your stop-loss limit as an insurance policy. When it hits that level, sell, sell, sell. Don’t think about it. Don’t try to second-guess the market, just do it. The strategy will allow you to protect your profits on the way up and also cut your losses on the way down.

A trader without a trading plan is like a car driver without a map, how are you ever going to get to your destination?

Overtrading

Before we examine the dangers of overtrading, there is one lesson you should remember first and foremost, let your winning trades run and cut your losing trades short. A report by finance experts Brad Barber and Terrance Odean casts a fascinating light on the returns posted by heavy day traders and those who were least active. The report showed that, on average, the more active traders underperformed the least active by 7% a year. What was the reason for this underperformance? Overtrading.

The key to trading success is emotional discipline. If intelligence were the key, there would be a lot more people making money trading… I know this will sound like a cliché, but the single most important reason that people lose money in the financial markets is that they don’t cut their losses short.”

– Victor Sperandeo

Trading costs along with the bid and offer spread on many investments can have a serious detrimental impact on your overall returns. Would you believe that according to the same report, investor losses in Taiwan were the equivalent of 2.2% of Taiwan’s gross domestic product in 2016. Most often this is a consequence of overtrading.

To address the issue of overtrading, remember one thing. You will never be judged on the number of trades you do each day, each month and each year. You will evaluate yourself, and others will evaluate you, by your ability to let your winning trades run and then take the profits at the right time. The issue of overtrading is a straightforward one to tackle. Focus on your investments, be cautious but don’t sell too early. You could catch a flurry of relatively small daily scalps, and one unfortunate trade might wipe them all out.

Cut your losses, let your winning trades run, and avoid overtrading. You won’t judge your own results based on the number of trades you made. Your evaluation will be based on the profit you make.

Succumbing to FOMO

The good old Fear of Missing Out (FOMO) is a tried and tested pattern of human emotions. It represents both fear and greed. Time and time again we see a split in investor forecasts for markets like the S&P 500 E-mini Futures. Sometimes bearish traders just can’t see why the index keeps getting stronger and stronger. It doesn’t make sense to them and they steadfastly hold their position. Slowly but surely the continued rise in the market begins to gnaw away at their confidence, they are missing out, the momentum is just too strong then finally they snap. They got it wrong, the market was undervalued and now they’re starting to panic.

When the last of the bearish traders are enticed over to the bull’s side, you can often consider it a sign that the top of the market is close. Those who have been holding positions since the beginning start looking to take their profit, the momentum starts to die, and the index begins to drift. We have seen this time and time again. Investors unwilling to follow the market, skeptical of market momentum, then eventually dragged in because of the FOMO.

What Causes FOMO?

When you decide to take a position, right or wrong, it would have done using your investment/trading strategy. The market appeared overstretched, overbought, and offering little value. At times like that, remember that you don’t have to be in the market all of the time. The longer you hold out before giving in, the higher the price you will pay for your futures contracts. You might have thought it was expensive 100 points lower, but suddenly it starts looking like good value even if it is significantly higher. Some might even call it a herd mentality.

Fear and greed drive markets. They can muddy the minds of investors and make people begin to doubt themselves. However, don’t let yourself get dragged into positions where you don’t feel comfortable. Don’t follow the crowd just for its own sake, because the more “overstretched” an index or stock becomes, the more significant the rebound when it finally succumbs to profit-taking. It almost behaves like an elastic band being pulled further and further away from reality. Don’t get drawn in!

The fear of missing out can sometimes be stronger than logic and slowly draw you in as prices move the wrong way. Don’t chase the last dollar!

Going Live Before Backtesting 

Have you ever heard the term, “don’t run before you can walk”, well this is the perfect way to describe those who go live before finishing their backtesting. Act in haste, repent at leisure. 

When you do your backtesting you will notice that the same technical patterns emerge time and time again. Learning how to read them, understand the markets, and make an informed decision makes a real and profitable day trader. As one famous day trader once said, being a little late on your trades gives the market time to catch up with your way of thinking. 

If you look back at the likes of Gordon Gecko and Bud Fox, these were day traders in the mold of the 1980s. They enjoyed the cut and thrust of the markets, insider trading, and banked huge “profits,” which created the new wave of day traders. If you think of backtesting and even forward testing as a form of “apprenticeship” before taking up the reins as a day trader, you won’t go far wrong. Can you do too much backtesting? Put it this way, can you ever know too much information?

History has a habit of repeating itself. Study the trends, study the signs and take your time before going live.

Not Forward Testing after Back Testing

Once you have done the backtesting, you understand trends, what makes markets tick, and the key signs to look out for. Is that enough? Those who backtest and then forward test (also referred to as paper trading) will actually be able to put their trading ideas into action in real-time. Obviously, when testing these particular strategies, no actual trades are carried out. Paper trades will show when you bought when you sold and what you could have done better, maybe. Learn from your mistakes before you put the monopoly money away.

If we were able to invest in hindsight, we would all be millionaires. If trading results were based on IQ tests, then only the cleverest would make money. It’s not. It takes confidence, an analytical mind, and the ability to make relatively quick decisions in fast-moving markets. Test yourself, test yourself again, and then go back, rethink, and test yourself once more. 

The only experience anywhere remotely similar to actual day trading is forward testing. Put yourself in the mindset, and try to feel the pressure of what to do next with one of your large trades. It isn’t easy, and you do need to get into the zone, but this is a priceless experience. You will feel your heart pumping, an adrenaline rush, and a feeling that you can take on anybody. Harness that motivation, determination, and drive but interact that with analytic thinking, trading strategies, and trading discipline, which comes with time.

Hindsight is a beautiful thing, back testing is very useful, but forward testing puts you in the driving seat, tightly holding the steering wheel and in full control. Just mind the bumps!

Going Live with too much Capital but not Enough Results

When you look through the financial press, it seems everyday trader is making a profit. To an outsider, it seems like easy money out there, and you need to get your capital invested as soon as possible. There is a delicate balance between spreading your risk/diversification and going all out on a limb. Yes, you want enough capital at risk to make a decent profit, but you also want to leave yourself enough in reserve to fight another day. It can be very tempting to switch from back/forward testing and hypothetical investment strategies to going all-in on the market.

It is extremely dangerous to trade live with too much capital and too few results to draw experience from. Profitable, breakeven and even losing trades during your paper trading will make you a sharper trader. They will help introduce discipline and simulate the feeling of making a profit and making a loss. Whether hypothetical or trading with reduced capital, you need to feel the pain of a paper loss to understand why it is important to cut your losers and run your winners. Test the water and get slowly acclimated to the market and how it feels to have actual money at risk.

When looking at any investment strategy, you need to have a sense of risk, a sense of balance, and a degree of certainty that you will have at least some capital to fight another day if it went wrong. Going all-in is just a shot in the dark and when it gets to that stage it becomes challenging to recover.

Appreciate the markets, embrace the risk, target the profits but never put all of your eggs in one basket. Very few day traders go “fully invested” just in hopes of one trade that will make or break everything.

Accumulating Data Across Different Market Styles

Stockbrokers need to know their clients, and day traders need to know their markets. Finding the right niche for your skills, your strategy, and your long-term aims will take time, but it is an essential task. For example, day traders need markets that are liquid, volatile with significant daily volumes because the last thing you want is to be stuck in a contract when it goes the wrong way. You need to know whether taking a profit or taking a loss, there is liquidity, and the market can accommodate large trades even in times of extreme volatility. 

We have seen innovation over the years, but the move to introduce the S&P 500 E-mini Futures Contracts was a game-changer. The S&P 500 E-mini Futures Contracts are 20% of the value of the original S&P 500 Futures Contracts. Although it was initially aimed at private investors, its introduction of these new contracts inadvertently attracted business away from the original S&P 500 Futures market and created the most popular futures market in the world. This market is open five days a week and 23.5 hours a day – with day traders given the weekend off for good behavior!

Why do day traders fail? Simple, many of them fail to do their research across different markets and fail to appreciate changing trends.

How to Avoid Failure and Become a Successful Day Trader

The above tips will put you on the road to becoming a successful day trader but even so, never stop learning and challenging yourself. Speaking of challenges, have you seen our Trader Career Path® challenge?

The Trader Career Path® is proving to be an extremely popular challenge for traders of varying experiences. Improve as you go by learning in real-time and in just 10 trading days you could secure funding from a proprietary trading firm. Many people have run the Trader Career Path® but only the ones who have what it takes passed. Do you have what it takes?

Do You Have What It Takes to Be a Successful Day Trader?

We know that many day traders fail to realize those regular profits, increase their assets year by year, and unfortunately, many seem to fall by the wayside. There are many ways to avoid failure and become a successful day trader. These include:

• Research, research, and more research.
• Backtesting, forward testing, backtesting, forwardtesting, you get the message.
• Plot your journey. Otherwise, how will you get to your destination? You need an investment strategy, and you need to stick to it.
• Sheep get slaughtered, believe in yourself, and stick to your principles if you need to make some slight adjustments, everything is flexible.
• Managing risk takes time and experience. If the potential return isn’t there, don’t take the risk.
• You won’t be judged on the number of trades you book each year but by the profits you make. As they say, “turnover is vanity, profit is sanity.”
• Never let your heart rule your head; emotion and day trading don’t mix.
• Believe in yourself!

You can do it!

The post Why do Most Day Traders Fail? Learn to Avoid Beginner Mistakes appeared first on Earn2Trade Blog.

What is the Stochastic Oscillator?

A stochastic oscillator chart allows you to identify momentum in the price of a financial asset. At the core of this indicator is the stochastic oscillator formula. It compares the closing price of a security to the recent high and low prices. You then convert it into a figure between 0 and 100 which is the actual stochastic oscillator value. This is where it starts to get interesting!

Let’s say you speak to two traders independently and ask them what the stochastic oscillator shows. There is a good chance you will get two vastly different answers. On the one hand, the stochastic oscillator is an indicator of momentum both upwards and downwards. On the other hand, some traders may see it as an indicator of overbought and oversold prices. Both explanations are correct in theory. The critical difference is how you use the indicator within your investment strategy. 

There are other factors to take into consideration. One of them is the period over which you take the low price and the high price. You will need to research the ideal indicator settings for your own particular trading method. Are you happy to go with a longer-term, flatter trend? Alternatively, would you prefer a more sensitive short-term indicator that might alert you to short-term trading opportunities?

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A Brief History

There is some debate as to the origins of the stochastic oscillator. Especially the %D indicators we will cover later in the article. Many believe that C. Ralph Dystant was the original creator of the indicator. However, George C. Lane is perhaps more commonly credited for his role in popularizing it. The latter also introduced several tweaks and adjustments.

We can trace the stochastic oscillator back to the 1950s when C. Ralph Dystant taught stock-market courses. In these courses, his original focus was on commodities. The classes were one of the first to focus on charting, moving averages, and other indicators to predict future price movements. Incidentally, George C. Lane supposedly started working for C Ralph Dystant in 1954. That was the same year as the retirement of technical “guru” Roy Larson. Was it a coincidence?

It would be fair to say that both C. Ralph Dystant and George C. Lane were integral to creating the stochastic oscillator indicator and the influence it still holds with investors today. In many ways, the key to its success is its relative simplicity. The masterstroke was introducing an easy-to-understand range between zero and 100. In the words of Kelly Johnson, former lead engineer at Lockheed Skunk Works, “keep it simple, stupid.” Many traders today refer to this quote as the KISS principle.

How Does the Stochastic Oscillator Work?

Now let us examine how the stochastic oscillator works. We will also take a look at how quickly you can adjust the sensitivity of the indicator. The basic concept behind the stochastic oscillator is momentum. It gives you the ability to monitor the momentum of an asset’s price. Doing so lets you see whether it is potentially oversold or overbought compared to recent highs and lows. However, therein lies a potential conundrum.

A Simple Example

What if we look at the S&P 500? The E-Mini S&P 500 futures contract is amongst the highest volume assets in the futures market. What will looking at its momentum show us? Picture the example of firing a rocket into the sky. It will not just suddenly stop and turn back to earth right away after running out of fuel. The fading momentum will continue to push it higher at a drastically falling speed. However, when the positive momentum eventually ends, the rocket will turn and head back towards earth. As a result, it builds up new momentum along the way. This is the idea behind the stochastic oscillator. Using the recent highs and lows for comparison, you should be able to identify a change in momentum. That result should be reflected in the charts as well.

There is a general consensus that when stochastic oscillator levels fall below 20, it indicates the asset is oversold. Meanwhile, if it moves above 80, that indicates the asset is overbought. Let us take 50 as our mid-value. In theory, the positive momentum is above the line, while the negative momentum is below it. Although this is generally the case, stay aware of possible false signals. Now let us move on and look at how to read and understand the stochastic oscillator indicator.

Stochastic Oscillator Formula and Calculation

In this section, we will take a look at the stochastic oscillator formula. We will also point out what elements of the formula you can adjust to change the sensitivity. The basic formula is as follows:

C = the most recent closing price

L14 = the lowest price traded over the last 14 trading sessions

H14 = the highest price traded over the last 14 trading sessions

%K = the current value of the stochastic indicator as a percentage

To give a practical example of how the indicator works, we will look at the S&P 500 index. This is the figure the E-mini S&P 500 futures contracts are based on.

Current level = 3490

Low point last 14 trading sessions = 3300

High point last 14 trading sessions = 3500

So the calculation is as follows:

3490-3300/3500-3300 = 190/200

(190/200) x 100 = 95%

Example

So, according to the stochastic oscillator indicator, the S&P 500 index has strong momentum and is potentially in “overbought” territory. Many people would class this as the standard stochastic oscillator indicator calculation based upon 14 trading sessions. However, how does the situation look if we base it on eight trading sessions?

Current level = 3490

Low point last 8 trading sessions = 3400

High point last 8 trading sessions = 3500

3490-3400/3500-3400 = 90/100

(90/100) x 100 = 90%

Finally, what indication does the calculation give us with a 30 period moving average:

Current level = 3490

Low point last 30 trading sessions = 3200

High point last 30 trading sessions = 3500

3490-3200/3500-3200 = 290/300

(290/300) x 100 = 97%

The shorter the period in question, the more sensitive the formula will be to daily movements. The reason is that the difference between the high and the low point should be relatively small, in theory. The S&P 500 index has strong momentum over 14 days and 30 days in the above three examples. However, it is notably lower if you only look at it for 8 days. However, they all indicate a potentially overbought scenario.

Other Important Formulas

You will also come across what traders refer to as the %D stochastic oscillator indicator. This is traditionally a three-day average of the %K indicator. The %D removes many of the short-term fluctuations in the %K base chart. That gives it smoother trend lines which are often easier to read. The downside of the %D is that emerging trends will show up later than in the %K. That is because it is a rolling average.

Then you have the slow stochastic oscillator indicator. The %D figure is traditionally a three-day rolling average over the %K three-day rolling average with the slow stochastic oscillator. We calculate the slow indicator, as well as the average indicator from the primary indicator. The latter is also sometimes referred to as the fast stochastic indicator. This creates an even smoother chart where movements above 80 and below 20 can be rare. However, we can consider them strong signals when they do occur.

How to Read Stochastic Oscillator Charts

Next, let us take a look at two stochastic oscillator indicator charts. We will highlight some of the turning points which could have proved beneficial for traders. The first chart is the traditional (fast) stochastic oscillator indicator with a smoother %D trend line based upon the %K factor.

The second chart is what we refer to as a “slow stochastic oscillator indicator.” It averages out the index level over a more extended period. Then we have the %D factor based upon the %K and gives an even smoother line. The longer you extend the period over which you examine the prices, including highs, lows, and current prices, the smoother the chart. However, there will be a significant lag. On the upside, in many ways, this can help to offset short-term peaks and bottoms that can sometimes tempt people into buying and selling when they should not.

Towards the start of this chart (after the initial fall), you will notice that the purple line, the short-term %K line, moves up through the %D line (orange line) around the 20% level. Many people believe this represents a strong buy signal.

Placing the Example on a Timeline

As it happens, this was the start of a rally in the index. The rally lasted until around the 24^th of July. After the initial rally from oversold (strong momentum) to overbought (weakening momentum), the stochastic oscillator indicator fluctuated just around the 80% line. A general consensus is that anything above 80 is potentially overbought, and anything below 20 is potentially oversold.

Interestingly, the short-term dip in the index from the 24^th July to 27^th July saw the indicator move from an overbought to an oversold position. When the %K line moved through the %D line on 27 July, it indicated another rally. That rally continued until 19 August. Then a short-term consolidation saw the trend lines dip under the critical 80% figure. That looked like a classic pullback after a strong rally. Not long after, the chart indicated another rally may be imminent. It was at the point when the trend lines crossed again, on the way up. 

How to Use the Stochastic Oscillator

The key to using the stochastic oscillator is finding the timespan that best suits your investment strategy. Those looking for short-term trades will focus on relatively short periods, prompting somewhat volatile swings in the indicator. Those looking for the confirmation of longer-term trends will extend the period in question. These charts will be smoother, and due to the extended lag, they are not as susceptible to short-term swings.

What Are the Best and Most Accurate Settings?

There are three variables to consider when looking at stochastic oscillator settings which are:

%K = based upon the number of time periods used in the calculation

Slowing = simple moving average (SMA) factor applied to %K

%D = %K moving average factor

As we mentioned above, the stochastic oscillator has three different types. These are:

The fast stochastic oscillator (traditional indicator)

Fast %K = basic calculation of %K over 14 periods

Fast %D = three period SMA of %K fast stochastic oscillator

The slow stochastic oscillator

Slow %K = fast %K expressed as a three period SMA 

Slow %D = three period SMA of slow %K 

The full stochastic oscillator

Full %K = Fast %K smoothed over a X period SMA

Full %D = X period SMA of full %K

The beauty of this system is that all of the above variations of the original indicator produce figures from 0 to 100. As a consequence, it is easy to compare and contrast the variation in trend lines. The greater the periods over which you calculate the simple moving average, the smoother the line. 

As we touched on above, the simple, fast stochastic oscillator will throw up many potentially overbought and oversold positions. Some of them will inevitably be false signals. As you can see in the charts above, the fast stochastic oscillator can be fairly volatile, often trading above or below the 80 and 20 levels for a short period of time. On the same chart, you can see areas where the %D (SMA figure) is not as volatile and does not always dip below or move above the 80 or 20 levels like the fast stochastic oscillator does.

Stochastic Oscillator Trading Strategies

There are many ways in which you can use the stochastic oscillator indicator to open positions, close positions, or even reduce your position if the chart is at a critical point.

Identifying overbought/oversold indicators

As you’ll see from the chart below, various handy indicators could have resulted in some significant profits. The first overbought indicator shows the fast stochastic oscillator figure reaching the 80% level and then sharply turning downwards through the three-period SMA. Many traders see these crossover points as strong indicators that momentum is changing, and the short-term trend may be about to reverse.

The second overbought position begins to emerge when the fast stochastic oscillator and the SMA move above 80%. A move above 80% or below 20% should not necessarily be seen as a signal to sell or buy but an early warning that momentum may be about to change. Many people prefer to wait for a sustained fall back below 80% or move above 20% before reacting – thereby cutting out a degree of volatility which can sometimes create false signals. This is where the SMA lines can be instrumental, smoother, and less volatile, although you won’t necessarily sell at the top because of the lag.

You can also see the two false overbought signals where the fast stochastic oscillator figure and the SMA dipped below 80. However, they reversed quite quickly as momentum picked up again and the chart moved back into higher territory. You will find that where there is a strong uptrend, which hasn’t been broken, at some point, there will be a pullback which can be an opportunity to buy on weakness. This is why the fast stochastic oscillator is more appropriate for short-term/day traders.

Bullish/bearish divergence

There will be occasions where there is a bullish/bearish divergence between the actual chart and the stochastic oscillator indicator. As you can see from the chart below, the low point of the chart would indicate the potential for further downside. However, when you look at the stochastic oscillator indicator, the trend moves in a different direction and is slightly bullish. This may well indicate the stock has bottomed out, and the momentum may be about to turn. One of the main signals to look at with this particular chart is the fast stochastic oscillator moving through the SMA line.

You’re just as likely to see a reversal where the main chart indicates an intact uptrend while the stochastic oscillator shows a slowing of momentum and a swing towards a downward trend. These are rarer trading signals, but they are fascinating, especially when you incorporate simple trend lines into the price charts.

Price trend indicator

The relationship between the fast stochastic oscillator and the SMA is significant. As you can see from the chart below, the first section is dominated by the strong downtrend with the fast stochastic oscillator and the SMA running downwards in parallel. Then there is a bounce in the chart followed by a move into more choppy waters with an obvious downtrend. As you will see, the indicators remain under the 20% level indicating that momentum is relatively weak. That is until the fast stochastic oscillator breaks through the SMA line towards the end of the choppy price action area.

This change in momentum is demonstrated by the uptrend, although it is not difficult to see where the momentum is starting to fade above 80%. When the short-term trend line breaks through the SMA and falls under the 80% level, this indicates yet another change in trend – a potential sell signal.

Advantages of Using the Stochastic Oscillator

Momentum is significant when it comes to trading, and there is no doubt that the stochastic oscillator indicator is a handy tool. There are several advantages to consider which include:

Sensitive to changing momentum

The shorter the period over which the high, low, and current prices are compared, the more volatile the stochastic oscillator indicator. SMA trend lines can also create powerful buy/sell signals when the lines crossover – especially above 80% and below 20%. This event would indicate that the short-term trend is changing and, assuming it continues, a new trend will follow.

Opportunity to identify bullish/bearish divergence

Due to the way that the stochastic oscillator indicator is calculated, you will, on occasion, see a divergence between the price chart and the indicator. While the price chart may indicate that a downtrend is still intact, the stochastic oscillator chart may already identify a change in momentum before the price changes. As you will see from the chart above, these can be powerful trading signals. How long you might wait to see if a new trend does emerge will vary between traders. How brave are you?

The formula is flexible

The shorter the period in question, the more volatile the stochastic oscillator indicator. Although there is the possibility of identifying short-term trading opportunities. However, you can extend the number of periods in question for those who have a longer-term investment strategy. This will flatten the volatile, fast stochastic oscillator line and give a smoother line, potentially making it easier to identify any change in long-term trends.

Risks and Limitations of the Indicator

As with anything technical indicators, the stochastic oscillator is not immune from false signals and is probably best used in tandem with other trading indicators. Some of the risks and limitations include:

False signals 

The shorter the period over which the fast stochastic oscillator is calculated, the more susceptible to extreme volatility. This can create numerous false signals, although the impact can be reduced by adding a simple moving average line.

Sideways trading

The indicator works best when there is either an emerging new uptrend, downtrend, or a short sharp period of consolidation before the trend re-emerges. During periods of sideways trading, this can create a relatively small gap between the high and low points, creating sharp movements in the indicator on relatively small price movements.

SMA lines lag trend changes

More extended periods to calculate the %K and SMA trend lines can make it easier to identify changes in the trend. However, you may miss a significant element of a changing trend due to the lag before you decide to buy or sell. You can adjust the full stochastic oscillator indicator variables to assist with your specific investment strategy, lengthening or shortening the periods, and adjusting the SMA.

Stochastic Oscillator vs Other Indicators

The stochastic oscillator indicator is extremely flexible, and you can adjust the periods and SMA variables to suit your investment plan. However, especially when looking at limited periods, there will be occasions where the indicator will create a false signal. Therefore, it is sensible to consider other means of technical analysis to clarify whether a potential change in momentum indicated by the stochastic oscillator is also reflected elsewhere.

Stochastic Oscillator vs RSI

While you can use both the stochastic oscillator and RSI (Relative Strength Index) to measure price momentum, they work on very different principles. The RSI measures potentially overbought/oversold positions by comparing recent gains to recent losses. The idea behind the stochastic oscillator is based on the assumption that the current price should follow the current trend. When the current price moves against the trend, it can indicate a change in momentum and a potential buy/sell signal. So who wins the fight, the Stochastic Oscillator or the RSI?

If the two oscillators were to indicate the same trend, this would be a powerful signal for investors. For example, if the price of an asset price was moving towards the top end of its recent high/low range, it would indicate positive momentum. Assuming that the RSI oscillator also shows a relatively strong trend, this would reduce the chances of a false signal.

Stochastic Oscillator vs MACD

The Moving Average Convergence Divergence (MACD) is a prominent momentum indicator, although it is very different from the stochastic oscillator indicator. You calculate the MACD by subtracting the 26-period exponential moving average from the 12-period exponential moving average. Many traders use the MACD technical indicator and the stochastic oscillator, often looking for crossover points between the two.

Those considering technical indicators from a distance might ask why traders don’t simply use three, four, five, or more technical indicators in tandem. The answer is simple; the time lag between different technical indicators can confuse the situation. By the time several different indicators have “line up,” you might end up missing the vast majority of the trend. There is nothing wrong with using just one technical indicator, but there are risks and false signals that can occur. Two is a company, three is a crowd?

F.A.Q

The post Stochastic Oscillator Indicator Explained – How it Works and How to Use it appeared first on Earn2Trade Blog.

What is Price Action?

It’s a favorite amongst short to medium-term traders. Price action trading brings together an interesting mix of information and different views. These include historical price patterns, technical indicators, and the investor’s ability to read the markets. Many investors see the stock market as an “information exchange” where all views and strategies meet and try to arrive at a “fair price” in the end. This explains why price action trading strategies do not involve fundamental analysis of an individual market/commodity.

A prudent speculator never argues with the tape.  Markets are never wrong, opinions often are.”

– Jesse Livermore

As many of the decisions associated with price action trading are subjective. What one investor may see as a breakout, another may see as a potential price reversal. Compare and contrast this with pure technical analysis where you effectively ignore investors’ experience in favor of cold hard trends. Human nature dictates that futures/commodity prices can be extremely volatile. Overbought situations are often created as a consequence of fear and greed, while panic selling can take over in the event of disappointing news. These are the type of scenarios where price action investment strategies can prove extremely lucrative.

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How to Read Price Action Charts

The key to reading price action charts is to take in short-term fluctuations. It’s also critical to notice emerging trends and focus on patterns that repeat time and time again. You will hear talk of swing patterns, support and resistance, wave analysis, trendlines, and moving averages, to name but a few different chart patterns. Candlesticks and bars are also very popular. 

For example, when a chart is about to crash through a support level, it is unlikely to do it in one fell swoop. You may see an index/commodity contract price initially bouncing off the support level as investors look to benefit from the short-term sell-off. As short-term traders sell into the bounce, buying interest begins to wane, and sellers again take control. Eventually, the price will crash through the support level, often prompting an array of short-selling. Next, let’s take a look at a few trading strategies based on various chart patterns in more detail.

Types of Charts

There are many different types of chart patterns we associate with price action trading. Some of these are fairly obvious, while others are open to interpretation. The following charts have been simplified to make a point. Once you understand what they really mean, you will start to notice many of them on the charts you look at every day.

Bullish Head and Shoulders

This chart illustrates an initial sell-off and then a period where buyers and sellers alternate control. Eventually, active shorters close their positions and panic sellers bail. Slowly but surely, the buyers regain control of the contract price until it eventually breaks through the neckline resistance. We can attribute the first rebound in the contract price to “bottom-fishing.” That is the point where sellers who failed to act on the initial fall take advantage. When looking at this kind of chart pattern, it also helps to keep an eye on trading volumes. Very often, you will see huge volumes towards the bottom of a downward trend. This typically indicates that an upturn is just around the corner.

Double Bottom

The double bottom trend is fairly straightforward. It is as closely related to technical analysis as it is to human nature. The initial large fall in price will tempt those closing short positions and those looking for a short-term bounce. After the initial bounce, those sellers who missed out on the previous downturn are determined not to miss out again. They push the price down to create a double bottom. There is an indication of support around the level of the two low points with a gradual recovery back towards the resistance level. What typically happens is that the initial sell-off goes overboard, and buyers return right after. This pushes the price through the resistance level and back towards previous levels.

Triple Bottom

In layman’s terms, this pattern seems very similar to the last one. However, when seen through the eyes of a price action trader, they tell a different story. This trend indicates significant selling action from the initial fall and those taking advantage of short-term rallies. These rallies push the contract price towards a resistance level which initially still holds. Due to a mix of stale bulls finally giving up on a price recovery, traders closing short positions, and new buyers, the momentum begins to swing strongly behind an upturn.

A clear positive indicator for many price action traders is when the price breaks the resistance level. However, those who saw the emergence of a triple bottom earlier may well have started buying on the earlier dips. You will regularly come across the term “buying on the dips.” It indicates that the buyers are slowly but surely drawing out the sellers after a downturn. 

Rounding Bottom

While some of the earlier price action trends were much more pronounced and less varied, the rounding bottom chart trend can be a little bit more difficult to spot. After the initial sell-off, there are various relatively small rebounds before the sellers regain control. This is demonstrated by the falling lows. At least until the price hits rock bottom towards the middle of the chart. This then prompts a rally with rising highs perfectly reflecting growing investor demand. The resistance level is a straight line between the far left and far right recovery highs. Once the price powers through that level, the buyers are in full control, and earlier sellers are left floundering.

If the initial trend of falling lows continued, it would’ve indicated sellers were disposing of their investments at the first sign of a recovery. Depending on how long the pattern continues, this could lead to another sharp sell-off with a support line drawn across the falling lows.

Bullish Island Reversal

The bullish island reversal chart pattern can be a difficult one to read in the early stages. The initial fall followed by a period of price fluctuation can easily turn into a bullish trend line, double or triple bottom. However, in this instance, the initial contract price fall creates confusion, with buyers more interested and sellers uncertain. This type of pattern often emerges when short sellers decide to err on the side of caution and close their positions. That together with “bottom fishers,” can prompt a sharp upward movement. A period of sideways trading is not necessarily exciting for those using price action strategies. However, once the price breaks through, the support level interest renews.

In this instance, the second stage of the chart trend is similar to a rounding bottom where buyers and sellers fight to gain control. Eventually, there is a breakout on the upside. That said, uncertain investors may decide to take profit after the initial burst – and stale bulls finally exit. This then creates a sideways trading pattern. Bulls buy on the dips, looking to acquire cheap assets, while uncertain sellers take advantage of the upward rebound. Once the stale bulls and short-term traders have been taken out, the next leg of the recovery comes into play.

Bullish Rectangle

This is a fascinating trend that perfectly illustrates that a bull run on a commodity price does not generally go up in a straight line. In various stages of the long-term bull run, those who acquire a lower down will be tempted to take profit. Meanwhile, those who missed the initial rally will look to buy on weakness. This creates a near-perfect period of sideways trading, with the price oscillating between resistance and support with no clear direction. In this particular scenario, eventually, the bulls take control of the day, breaking through resistance and moving into new higher ground.

The share price could easily have taken a further downturn if the support line had been breached before the two occasions when the price bounced higher. This is a perfect illustration of how price action trading strategies are very much removed from fundamentals. They basically just play on new emerging trends.

Bullish Wedge

Traders call this chart trend a bullish wedge because eventually, the share price breaks out into new ground and moves higher. However, it is also a powerful indicator of a bearish period in the early stages. As you can see, once the share price turns after the initial rise, the gap between the short-term highs and short-term lows begins to decrease. The line at the bottom is the support, and the line at the top is the resistance. Due to their angles, they will eventually meet with one of them taking control. You will often see the downward restricted trading range continue until the support and resistance trend lines almost meet. A breakthrough in the support level would indicate another sell-off, while in this instance, a breakthrough the resistance introduces a new uptrend.

Ascending Triangle

This is another exciting trading trend. An initial rally is hit by profit takers. This causes a short-term downturn before the buyers re-emerge. The interesting element of this particular pattern is the rising lows while the resistance continues to hold at a fixed level. This indicates that not only are there fewer sellers, but buyers are content to buy at high levels. Their view is that the contract price will eventually break through the resistance level. You will notice that these broadly sideways trading periods see bulls and bears once again battling for control of the underlying contract. Once on higher ground, all bets are off, and sellers retreat as the buyers step forward.

Bullish Flag

Once the initial rise in this price begins to succumb to sellers, we see the emergence of a new downtrend. The short-term lows continue to fall, as do the short-term highs as the price rebounds begin to weaken. This creates an initially bearish trend from which it can be difficult to escape without a bout of good news. As the short-term highs move lower, this indicates that buyers are unwilling to “pay over the odds” with the price succumbing to sellers. Eventually, the contract will reach an oversold position. What follows is a move outside of the flag range. This draws in price action traders who have spotted the emergence of a new trend.

After most sellers have already left and the shorters close their positions, there can often be immense momentum behind a recovery from this type of oversold position. It is not difficult to see where the term flagpole comes from, at least until the eventual breakout! 

Cup and Handle

The cup and handle chart trend is a perfect example of a slow burn recovery followed by a sudden pullback when buyers have had their short-term fill. Similar to the bullish wedge, the short-term downtrend suddenly breaks, leading to a sharp upward spike. This type of chart pattern is fairly common when prices rise sharply. Between the second upward turn, the bears and bulls battle for control, with some investors banking a profit while others look to buy on weakness, believing the uptrend is still in place. Boredom and impatience can often lead to the handle shape before the uptrend, with investors concerned that the price is moving into a downtrend. Once sellers have been taken out, the buyers then take control. This moves the price significantly higher due to a lack of resistance.

These are just a few of the fundamental trading patterns that price action traders use when looking to take advantage of new trends emerging on the upside and the downside. It is now possible to go both long and short on various commodities and contracts. This creates an extremely liquid market. The perfect environment for short to medium-term traders!

Price Action Trading Strategies

The key to any successful price action trading strategy is to remove peripheral noise such as fundamental data and look at price patterns, trends, and other forms of technical analysis. When combined with good old-fashioned experience and “a feel for the market,” this can create a very successful investment strategy. Don’t forget, even if you have opened a position based on any of the following price action trading strategies, you can also use the technical data to set stop-loss limits.

Support and Resistance levels

One of the key aspects of price action trading when using support and resistance levels is that once a support level is breached, it can then turn into resistance and vice versa. The following chart shows how chart analysis can change in a relatively short span of time. It is worth noting that while traders tend to focus on volatile periods for contract/commodity prices, the vast majority of the time, they tend to trade sideways markets, all within a relatively modest range. 

It is foolhardy to make a second trade if your first trade shows you a loss. Never average losses. Let this thought be written indelibly upon your mind.”

– Jesse Livermore

On the chart below, you can see prices moving in a relatively tight range. It bounces off the resistance and support lines on multiple separate occasions. When the eventual breakthrough did happen, it signaled an uptrend. That trend initially looked as though it was faltering early. However, it then bounced off the previous resistance, which was now a support line, moving even higher.

Inside Bar patterns

Many price action traders are extremely vigilant. They’re always on the lookout for what are known as inside bar patterns. You can recognize these by the emergence of a secondary bar within the body of the previous bar. Take a look at the examples below:

The primary bar is sometimes described as the “mother bar” and will often indicate a period of consolidation and potential turning points from key support/resistance. You will see on the chart below how the bar indicates a rising price then incorporates two falling bars. This is the beginning of a changing trend and marks a downward movement. To see one mother bar/inside bar occurrence is encouraging. To see two inside bars side-by-side is an even more reliable indicator.

It is only when you take the time to understand how bar patterns emerge and what they indicate that you can position your trades. Don’t forget to also keep one eye on the stop-loss limit.

Pin Bar and Inside Bar combo

The pin bar and inside bar combo pattern is seen by many as one of the most powerful technical indicators. As you will see from the example below it can also prove extremely lucrative if you accuratelyrecognize it in time. The pin bar and inside bar combination shows what is effectively a short-term sell-off, before the exchange rate consolidates and then moves significantly higher. If you look towards the start of this particular chart you can see the exchange rate bounce off the resistance (later support) level with the pin bar and inside bar combination highlighting the peak.

A basic pin bar and inside bar combo is already a good sign. When you also see the inside bar form within or near to the pin bar nose that is an even stronger signal. In reality the pin bars on this chart are talking to price action traders. Those who learn to understand their “language” can set up some very lucrative trades.

How can Price Action help with your trading? 

As you’ll gather from all of the above information, price action trading is based on trends and momentum. The idea is simple, once a trend changes, then the momentum often grows. It is only when a stronger (opposing) trend emerges that the direction changes again. Between these relatively strong trends, there will be periods of consolidation. Often you can also find sideways trading, and prices will often bounce off support and resistance lines. In many ways, support and resistance levels are self-fulfilling prophecies. Many traders now use technical analysis and take them into consideration. However, price action trading offers the best of both worlds with both technical analysis and human input from a trader.

Don’t take action with a trade until the market, itself, confirms your opinion. Being a little late in a trade is insurance that your opinion is correct. In other words, don’t be an impatient trader.”

– Jesse Livermore

Disadvantages of Using Price Action as an Indicator

There are numerous disadvantages and advantages of using price action trading strategies, and ultimately it comes down to how disciplined you are as a trader. Some of the disadvantages include:

Relatively low number of trades

As you effectively wait for the price trend to cut through a support level or shoot through a resistance level, you can end up with a relatively low number of trades. That is not an issue if you are disciplined, but frustration can sometimes get the better of traders!

Waiting for definitive levels

Unfortunately, traders using price action trading are often caught out by significant shifts in the market. This often means prices do not return to their preferred trading levels. Traders lacking discipline can end up “chasing the price” higher and higher. Meanwhile, for those who can remain focused on the technical situation, opportunities will emerge.

Definitive changes in trends

Many of the strategies we mentioned above can be seen as “overly cautious” by some people. When waiting for a definitive change in trend, there may be times when intraday prices could spike above resistance or below support then recover. These could be seen as false flags and can be potentially expensive in the long run.

No fundamental analysis

When looking at chart trends, not all traders will have the same opinion. Some will go long, and others will look to short the market. These decisions are based on their opinion of the technical analysis as opposed to fundamentals. Whether you are actually ignoring the fundamentals is debatable because, in theory, contract prices today should reflect all of the information in the public domain. Basically, let the markets talk and listen to what they are saying.

Price Action Trading Examples

As we touched on above, while price action trading is based on technical analysis and a reading of the situation, it is not always cut and dry. Some examples of price action trading include:

After hitting a new high an exchange rate falls back as a result of profit-taking

While it will depend on the support and resistance levels, one trader may expect a double top and then a move to higher ground. However, a different trader may see this as the start of a new downward trend. In that scenario, continued profit-taking could push the price below the support level. 

Low volume sideways trading

One classic indicator that a trend is changing is high trading volume. So, if the price is stuck in a bound range, bouncing between resistance and support under relatively low volumes, one investor may see this as a trading opportunity. While another investor may see this as a lack of interest and assume a likely break through the support level at some point, prompting a strong momentum downward trend.

History repeats itself

In many cases, you will see currency exchange charts indicating historic highs and historic lows. Many of these patterns are very strong, but you will see a significant break out on the upside or the downside every now and again. So, one trader may take a position assuming history will repeat itself, and there will be a ceiling and a floor for the trading price. Another trader may assume that the momentum behind the uptrend is strong enough to push it through historical resistance and into new territory. This move into new territory can often be a breath of fresh air because there are no similar historical trends to compare it against and no resistance to speak of.

F.A.Q

The post Price Action Trading Strategies That You Need to Know appeared first on Earn2Trade Blog.

Gauntlet Mini

But what now? Do you still need to follow the rules? What happens if you make a nice profit? How can you withdraw funds? What happens if you blow your funded trading account? There are a lot of questions that need an answer. 

This article will help you better understand what happens after you join our funded trading program and once the real trading begins.

What Happens After You Get Funded?

Candidates who pass the Gauntlet Mini will receive a guaranteed offer for a funded trading account with our proprietary trading partner. It will be the same size as the one used to pass the evaluation.

With the Trader Career Path®, you will begin with a capital of $25,000–$100,000 and follow a growth plan, where you can grow your account to $200,000 or $400,000, depending on the selected plan. The best among you will be able to even go beyond that and receive a customized offer.

There are two types of funded trading accounts available after passing the evaluations:

LiveSim® Accounts

The LiveSim® account is a virtual account that allows you to continue sharpening your skills in a simulated environment while having the benefit of withdrawing your profit. Although no trades on the account are executed on a live exchange, the simulation is traded through a live data connection from Rithmic.

The prop firm offers this as an optional step for traders who don’t think they’re ready to jump into live trading. Think of it as a bridge between trading on a simulator and trading on a live account. Furthermore, it grants you advantages like faster setup time (you can start trading in just two business days after accepting the funding agreement) and a NinjaTrader® license from Earn2Trade.

This option suits traders who want to mitigate the stress of live trading but still make money if they perform well. As stated above, this is an optional step and not necessary if you want to start trading live immediately.

For traders who chose a LiveSim® account upon completing the Gauntlet Mini, it is only available until you make your first $5,000 (minus the 20% profit split – more on this later).

For those who passed the Trader Career Path® evaluation, LiveSim® will be available until you reach the profit target of $1,750 in the TCP25 or $3,000 in the TCP50 (minus the 20% profit split).

After that, you will be automatically switched to a Live account.

Furthermore, traders with non-professional status pay a $139.00 account activation fee, deducted from their first profit withdrawal. Those with professional status will be charged $135/month/exchange.

LiveSim® accounts calculate drawdown the same way as on your evaluation account.

Live Accounts

To really experience being a professional trader, you should pick the Live account. In the Live account, you will be trading on your preferred platform, with your orders being processed directly through a brokerage to the CME. The setup time is a bit longer (up to 10 days) because there is a necessity for registering with the brokerage. However, in the end you will be regarded by the CME as a professional trader and have the opportunity to trade with the prop firm on the live market through a real futures account at an FCM (Futures Commission Merchant).

Keep in mind that on Live accounts, the trailing drawdown is calculated on intraday open equity gains and losses. Monthly data fees on Live accounts are $135 per exchange.

What Is Your Profit Share as a Funded Trader?

Now that you have received your offer after passing the Gauntlet Mini or the Trader Career Path® challenge, you are probably wondering what the next steps are. 

For starters, you can take advantage of an 80/20 profit split scheme that works in your favor. The profit split system is among the most generous in the industry, so you have the prerequisites to build your way up. However, to succeed, you should maintain the discipline and the behavior you have gotten used to during the evaluation. 

While obvious, it is important to state a crucial fact regarding withdrawals. You can only withdraw funds when you have positive account performance. In other words – you can’t withdraw any of the initial capital that the prop trading firm has given you, but only the profits you have earned with it.

You might also enjoy:

• What is The Daily Loss Limit Rule in Funded Programs?
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When Can You Withdraw Your Funds?

The minimum amount you can withdraw is $100. So, as soon as you have $100 in profits, you can cash them out (please note that on LiveSim® accounts, for the first withdrawal only, the trader needs at least $239 in profits to cover both the minimum withdrawal amount and the one-time account activation fee).

While you can withdraw funds from your funded trading account at any time, with the Trader Career Path® program, you are also required to do so each time you hit the profit target of your current account. Once you withdraw the entire profit, your account will be upgraded to the next one to increase your capital and bring an even more flexible drawdown requirement.

Withdrawal requests are processed once a week, every Wednesday. To ensure that your funds are withdrawn on time, you should email a request to the prop trading firm by 2 p.m. CT on the prior Friday.

What Are the Withdrawal Rules?

The withdrawal policy of Earn2Trade’s funded trader programs is flexible and transparent. The main rule is that you can withdraw only the profits earned and not the capital that the prop firm has granted you. The profit split scheme is 80/20 in your favor.

For example, the profit goal of the TCP50’s Live Trading Account ($50,000) is $3,000. Hitting it will ensure you can withdraw $2,400 (the $3,000 profit goal – the 20% share of the prop firm). You can handle the withdrawals either by cashing out the entire sum at once or over several transactions.

You can choose to withdraw via the following:

• Bank Wire
• Crypto withdrawal

These withdrawal methods are provided through a partnership with Rise, an international contract and payment management platform.

Are You Obligated to Keep Following All the Rules?

Before answering this question, let’s think about it for a moment. Why would you look to break the rules if they allowed you to pass through the Gauntlet Mini or the Trader Career Path® challenges? Whether virtual or live trading, the key to success is discipline. Now that you have instilled it, keep up.

The rules are mostly the same when trading as a funded trader as when you took on the original challenges. Because the proprietary trading firm providing the funds takes on all the financial risk, your account will have a few safeguards to protect its capital. This is a measure against situations where traders successfully pass the evaluation, then for some reason can’t handle the switch to a live market.

Drawdown

The number one safeguard is the trailing drawdown. Similar to your evaluation, with the funded trading account, the drawdown will again stop trailing once its threshold value (the balance where your account gets liquidated) reaches your starting balance. Alternatively – after your balance goes above the starting balance by the allowed drawdown value.

The drawdown is pegged to your positive account performance and is adjusted at the end of the day and updated after market close. That means if you increase your profit by $1.00, then your minimum account balance will also rise by $1.00.

For example, the allowed drawdown for the $50,000 account is $2,000. So, you shouldn’t fall below $48,000. If you make $100 in profits, the minimum account balance will also rise by $100 (to $48,100). However, once the threshold value reaches your account’s starting point ($50,000), it will stay there.

There is also a fixed drawdown that you shouldn’t dip below. Learn more about it here.

Other rules

Initially, your funded trading account will have a daily loss limit, just like during the evaluation, but the difference is that for the funded trading account, this rule is only temporary. Once your trailing drawdown stops trailing (see the above example), your daily loss limit can be permanently removed upon request. The rules concerning approved times and maximum position size (including the progression ladder) remain the same.

There is only one new rule added to the mix. Your account will get terminated after an unscheduled absence of five consecutive trading days. This rule serves a crucial purpose. Capital provided to traders by the prop firm can’t be allocated anywhere else. That’s why they are interested in preventing traders from simply claiming their funded account and not doing anything with it. It’s also critical to point out what the word “unscheduled” means. Traders can take time off from trading for whatever reason as long as they notify the prop trading firm. Some case-by-case restrictions may apply here, so don’t expect to take half a year off trading, for example.

What Costs and Fees Are You Responsible For After Getting Funded?

There are different types of fees that you will be charged with by third parties, including:

Data Fees

During the Trader Career Path® / Gauntlet Mini evaluations, traders with a “non-professional” status on the CME don’t incur any out-of-pocket data fees (“professional” traders will be charged $135.00/month per exchange). However, once you successfully complete your evaluation, you will need to pay for accessing CME’s live data. 

The fee amount depends on your chosen type of trading account:

• LiveSim® Account – traders with a non-professional CME status are charged a one-time account activation fee of $139.00 that covers all four CME exchanges. This amount is deducted from traders’ first profit withdrawal, which means there are no upfront out-of-pocket costs. After passing, you have 30 days to activate the LiveSim® account (delayed starts are acceptable). Traders who specify their CME status as “professional” will be charged $135.00/month per exchange.
• Live Account – the fee is $135.00/month/exchange. Note that these are pass-through fees from the exchange, and they can change at any time.

The fees are charged to your credit card (or other payment method) before the end of each month for the following month. Note that the CME charges data fees per calendar month and even if the data is turned on in the last week of a month, it will still charge you $135, regardless of how many days of that particular month you use the data. 

However, there are some tips that you can use to cut costs. For example, we generally recommend starting with only one exchange at first. Only add more once you’ve built up your account balance a bit. We also suggest not starting your funded trading account near the end of the month. Starting at the beginning of the month means you don’t get charged for both the first and second months right away at the same time.

If you already have a data feed of your own for charting and simply want to execute on the prop firm’s feed, you do not need to subscribe to their data feed and do not incur any costs.

Withdrawal Fees

The prop firm charges $10.00 per withdrawal (pass-through fee to Rise), which is waived for withdrawals over $500.00.

Platform Fees

Unless you’re using a free trading platform, you will also be responsible for your own platform fees. Most traders who take the evaluation already have their own platform license, so they don’t need to purchase a new one when they get funded. If you don’t have one yet, you can purchase NinjaTrader at a discounted price – see the details here. The Finamark platform also comes with three months of free access after getting funded. However, it needs to be purchased afterward if you plan to keep using it.

All platforms are made by 3rd parties, and their prices are set independently by their respective vendors. If you’re looking for a free platform option, we recommend R | Trader Pro.

Other Fees

There are some other fees and commissions that you should know about, including NFA, exchange, FCM (up to $0.54 and $0.46 per side for full-sized and micro contracts, respectively), and other fees. You can learn more about them here. 

While the structure of the fees might vary, here is a basic example that illustrates how the total per-side fee forms.

How Much Can You Make Now That You’re Funded?

If you stick to the rules and stay above the trailing drawdown limit set by your starting account size, there is no upper limit to how much you can earn. That being said, don’t expect to get rich quick. Trading is difficult and requires a lot of time and patience, and the unfortunate truth is that the majority of traders will not make money in the market.

Slowly building up your account and showing restraint may seem tedious, but by remaining patient and following good risk management, you are more likely to succeed, and with the Trader Career Path®, you have a clear growth plan to follow and keep you motivated.

As mentioned above, the key factor here is that you need to stick to the rules. Keep a close eye on your trading positions, spread the risk, and find a balance between maintaining liquidity and withdrawing your profits. While you will be able to open more positions as your profits rise, it is not mandatory to scale up. If you see an opportunity, you can work in a position within your restrictions, but if you don’t feel comfortable scaling up, don’t do it.

While the promise of short-term profits may seem tempting, remember this is a marathon, not a sprint. Your account will remain open as long as you remain above your trailing drawdown limit and abide by all of the rules.

What Happens if You Blow Your Funded Trading Account?

As a trader, you will live and die by your decisions, investment strategies, and trading discipline. Unfortunately, if your account balance dips below the trailing drawdown, your account will be automatically closed and terminated. Although futures trading has the potential to make money whether the markets are going up or down, there are still cases of unexpected volatility that can ruin your day.

That’s why you should always keep one eye on limiting losses and the other one on maximizing profit. The hustle and bustle of a heavy trading day can make it easy to lose focus, and traders always need to be aware of that danger. Use your evaluation experience to perfect your investment strategies and tighten your discipline. In summary, treat your funded trading account as the unique opportunity that it is!

How to Avoid Losing Your Funded Trading Account?

Initially, the rules for the funded trading account are the same as the evaluation challenges. You must not:

• Reach or dip below your daily loss limit
• Exceed the maximum position size
• Trade outside of approved hours
• Reach or dip below your trailing drawdown
• Exceed progression ladder limits

As mentioned earlier, there is also one new rule to keep in mind:

• Unscheduled absences of five consecutive trading days will result in your account being terminated

All you have to do to avoid losing your funded account is to continue trading with the same principles that helped you pass the evaluation. You’ve already proven that you can do it. Now, you just need to keep going.

If it feels like too much pressure, that’s not a problem either. Sometimes, it’s better to take a break because forcing yourself to trade can often lead to poor outcomes. That’s why the rule against missing a week of trading has a provision to allow you to contact the prop trading firm to schedule an absence.

Basically, remember what made you succeed in the first place, then do more of it.

Conclusion

The concept behind the Gauntlet Mini and the Trader Career Path® evaluations is simple. Find trading strategies that work for you, reduce your risks, cut your losses, and doing so will help you maximize your profits. The key to any trading account is discipline. Proprietary trading firms are more interested in long-term steady partners/traders than those with a volatile track record. The 80/20 split of profits allows our partner firm to create a revenue stream for successful traders. It also incentivizes new traders to take a more long-term approach, maintain discipline, and use the investment strategies that brought them success in the first place.

The post What Happens After You Get Funded with Earn2Trade? A Complete Guide appeared first on Earn2Trade Blog.

What is a Butterfly Spread?

Firstly, the term butterfly spread relates to the spine and the wings of a butterfly when fully open. In investment terms, the spine is the current asset price. Meanwhile, the size of each wing is the area of fixed risk and reward. Therefore, a butterfly spread will use three different strike prices: The lower price, current price, and a higher price.

When writing an option contract, you will receive a commission to allow someone to buy (call) or sell (put) an asset at a fixed price over a fixed period. When acquiring an option, you will pay for the opportunity to buy (call) or sell (put) an asset at a fixed price over a fixed period. For example, a butterfly spread strategy involves four options. These could be four call options, four put options, or a mixture of the two.

How does it work?

Using call and put options, you can create an array of different investment positions. Investment indices such as the E-Mini S&P 500 Futures are incredibly liquid and often volatile. However, offer the perfect opportunity to create several butterfly spreads. The more liquid the underlying market:

• The lower the chance of the market mispricing assets
• The greater the opportunity to deal in large contract sizes
• The fewer restrictions, even in fast-moving markets

All types of butterfly spreads take into account the intrinsic value and the time value of an option. For example:

• Asset price: $60
• Call option strike price: $50
• Three-month call option price: $15

Upon purchase, the call option price consists of:

• The intrinsic value of $10 (the difference between the call price and the asset price)
• Time value $5 (relating to the three month option period)

So, let’s assume the price is $60 on expiry in this scenario. The call option would be worth $10 as the time value will have eroded. Thus, by cleverly taking advantage of a mix of call and put options, intrinsic and time value, it is possible to lock in some potentially significant profits.

Butterfly Spread Types

Next, we’ll take a look at the different types of butterfly spreads. Then, finally, we’ll examine their structure and under what market conditions you can best maximize profit and minimize risk.

Long Call Butterfly Spread

Before we look at this option in more detail, it is crucial to realize what this type of spread entails. A long call butterfly spread, looking to take advantage of low volatility, consists of:

• The purchase of one in-the-money call option (strike price less than asset price)
• The writing (sale) of two at-the-money call options (strike price equal to asset price)
• The purchase of one out-of-the-money call option (strike price more than asset price)

You are taking advantage of the time value of the at-the-money call options, selling to receive income. The purchase of the out-of-the-money call options would be an insurance policy if the asset price increased significantly over the period. The purchase of the in-the-money call option provides cover for the written options. This position will create a net debit.

Short Call Butterfly Spread

As we will demonstrate in a moment, a short call butterfly spread means increasing your returns on significant movement, either upwards or downwards. The position itself consists of:

• Writing one in-the-money call option at a lower strike price
• Purchasing two at-the-money call options
• Writing an out-of-the-money call option at a higher strike price

The key to this short butterfly strategy is purchasing the two at-the-money call options and the receipt of income from the written options, creating a net credit. If the asset price fell below the lower strike price, all options would be worthless on expiry, and you would take the net credit as your profit. Conversely, if the asset price were to rise above the higher strike price, the value of the two at-the-money call options would cover the two written options and more. This position would create a net credit when first set up.

Long Put Butterfly Spread

The long put butterfly spread strategy is a means of benefiting from a relatively stagnant market. The make-up of the four options contracts is as follows:

• Purchase of a put option with a strike price below the asset price
• Writing two at-the-money put options
• Purchase a put option with the strike price above the asset price (in-the-money)

In this scenario, the best outcome would be if the asset price was to expire at the same price as the at-the-money puts. This situation would enable the investor to take advantage of the time value with the at-the-money puts while maximizing the in-the-money value. The out-of-the-money put option is simply an insurance policy in case the asset price was to collapse. Thus, the initial strategy creates a net debit.

Short Put Butterfly Spread

The short put butterfly spread strategy is a means of benefiting from significant volatility in the market. The system itself is made up of:

• Writing one out-of-the-money put option
• Purchasing two at-the-money puts
• Writing an in-the-money put option

In this scenario, you would maximize your profits if the asset value was above the highest option price or below the lowest option price on expiry. The worst-case scenario would be if, over the period, the price did not move. As a consequence, the at-the-money put options would be worthless. The lower written put option would also be useless, and therefore there will be no need to repurchase it to close the position. 

So the maximum downside with a short butterfly strategy would be the difference between the higher and the middle strike prices, less the written option income. So there is a net credit when setting up a short put butterfly spread.

How to Use the Butterfly Spread in Trading

When looking at a butterfly spreads, there are two main issues to take into consideration regarding the expected movement of a stock or index:

Minimal Volatility

Suppose you believe that a stock or index will experience minimum volatility over a specific period. In that case, you can use long call butterfly spreads and long put butterfly spreads to create a position. There will be a net cost to set up this strategy, but that will be your maximum loss. You can calculate the maximum potential profit when opening the position.

Expected Volatility

If you expect volatility on the upside or the downside with a particular stock or index, it may be sensible to look at a short call butterfly spread or a short put butterfly spread. As you are buying at-the-money calls/puts, there is no intrinsic value, just time value; thereby, movement in the “right” direction will maximize your profits.

Simplifying Butterfly Spreads

The key to the profit or loss on any butterfly spread revolves around both the intrinsic value of an option and the time value. The inherent value is the basic price differential between the strike price and the actual stock/index price. For example, if you had an option to buy the S&P 500 at 4200 and the option expired with the index at 4300, the intrinsic value would be 100. As the option had expired, there would be no time value. However, if, for example, you bought a three-month option, on purchase, the price would include any intrinsic value and an element of time value (which would slowly erode as you near expiry).

You tend to find that at-the-money options are more popular and generally have a greater degree of time value included in the option price. This is simply a case of supply and demand: the more demand, the greater the option price. Thus, time value is often described as the premium.

Options or Futures?

When looking to trade the S&P 500 index, the most popular method is the S&P 500 E-Mini futures market. However, it is also possible to trade the S&P 500 index via S&P 500 E-Mini traded options. Futures and options markets both trade on three-month contracts, although there is one main difference. With the S&P 500 E-Mini futures market, you can only buy or sell the index futures price at that time. However, those looking to undertake butterfly spreads on the S&P 500 can use the S&P 500 E-Mini traded options market.

The S&P 500 E-Mini traded options market offers a range of strike prices out-of-the-money, at-the-money, and in-the-money. Consequently, and due to the huge liquidity this market attracts, you can create your own butterfly spreads based on the S&P 500 index.

S&P 500 E-Mini futures prices are constantly changing in tandem with the S&P 500 index. Unfortunately, it is impossible to create the type of butterfly spreads we have discussed in this article using the futures market. However, many people create a different type of spread that allows you to buy/sell a short-term futures contract to let you counteract this by buying/selling a longer-term futures contract.

This type of spread involves contracts with different expiry months. Therefore, it is more often referred to as a calendar spread.

In conclusion, the only way to undertake a butterfly spread is by using the S&P 500 E-Mini traded options market. This allows you to pick and choose in-the-money, at-the-money, and out-of-the-money options, taking control of your maximum gains/losses.

Examples of Using the Butterfly Spread

We will now look at some examples of butterfly spreads based on ABC Company which is currently valued at $100. In this instance, we will use a lower strike price of $95, an at-the-money strike price of $100, and a higher strike price of $105.

Long Call Butterfly Spread

This is the trading summary when setting up a long call butterfly spread. You buy an in-the-money call and an out-of-the-money call while selling two at-the-money calls.

We will now take a look at the impact of the position on expiry. Let’s take in several different prices. As you can see, the worst-case scenario is a loss of $1.25. The best-case scenario is a profit of $3.75.

Short Call Butterfly Spread

This is when a short call butterfly spread, selling an in-the-money call an out-of-the-money call while buying two at-the-money calls.

This is the range of outcomes taking into account an expiry price between $90 and $110. The maximum gain is $1.25, while the maximum loss is $3.75.

Long Put Butterfly Spread

When setting up a long put butterfly spread, you will buy an in-the-money and an out-of-the-money put while selling two at-the-money put contracts.

The range of outcomes for a long put butterfly spread, taking into account a price of between $90 and $110 on expiry, is as follows.

Short Put Butterfly Spread

A short put butterfly spread will see you sell an in-the-money put and an out-of-the-money put while buying two at-the-money puts.

With a range of expiry prices between $90 and $110, you can see that the maximum profit is $1.25 while the maximum loss is $3.75.

Obviously, these figures are relatively small. However, they give you an idea of the potential capped losses and gains you can create using butterfly spread strategies. Of course, ramping up the number of contracts will impact the potential profit and potential loss. But, conversely, they will always be capped.

Butterfly Spread Risk/Reward

The key to a butterfly spread is that both losses and gains are capped when you open the position. You need to open all four contracts simultaneously and close the contracts at the same time to maintain this control.

Long call and long put butterfly strategies take advantage of a lack of movement and the receipt of time value on at-the-money options. These types of butterfly spread options are useful for markets that are trading sideways or stocks that have perhaps recently had their results, with little or no further news expected in the short term. As a result, you can often see investors, especially traders, exiting stocks just before or just after the results.

The Short call and short put butterfly strategies try to bank on a degree of volatility on the upside or the downside. The purchase of at-the-money options is relatively cheap. At the same time, writing an in-the-money option creates a degree of income. Short butterfly strategies are useful when a market or a particular stock has risen to unsustainable highs without additional news flow. If further news flow comes, the price may move higher. Meanwhile, a lack of additional news could see profit-taking. Either way, there is a good chance of volatility in the short to medium term.

The potential return will depend upon the underlying option prices, which will take into account the intrinsic value and time value. As at-the-money option series tend to be more active, the time value is often greater than those for out-of-the-money options. However, as you will see from the examples above, it is fairly easy to work out the risk/reward for any butterfly spread strategy.

Final Thoughts

When you strip down the basics of any butterfly spread strategy, short butterfly or long butterfly, the key is utilizing the time and intrinsic value in option prices. The fact that you are also taking positions as insurance can capping both the upside and downside. In this case, looking to protect your portfolio while maximizing any short and medium-term market fluctuations can be a useful means of creating additional income.

The post Butterfly Spread Guide – Explaining the Short Butterfly Spread and More appeared first on Earn2Trade Blog.

What is a Golden Cross?

In the eyes of many traders, the Golden Cross is the Holy Grail of bullish technical indicators. To flatten out short-term volatility, traders traditionally use the 50-day moving average and the 200-day moving average. When a 50-day moving average moves up through the 200-day moving average, they often see it as a confirmation of an emerging bullish trend. Mainly due to the lag on the two moving averages. In theory, it indicates short-term momentum and a potential change in trend direction.

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• Commodity Channel Index (CCI) – How to Use The CCI Indicator
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What Does the Golden Cross Tell You?

When you encounter a Golden Cross, it is safe to say that no two charts are ever identical. However, there are three distinct stages of the Golden Cross, which are:

Buyers taking control of a downtrend

By definition, due to short-term weakness in the 50-day moving average, a Golden Cross will occur after a downtrend. The resulting strength in the 50-day moving average comes about when the short-term sellers dry up and the buyers begin to take control. The chart will level out, and then buyers move into the driving seat, with the price moving higher.

Momentum moves the 50-day average through the 200-day average

This is the turning point. The 50-day moving average will eventually push up through the 200-day moving average if the upward momentum continues. This is the point at which the eyes of many traders will light up! Is this a new trend or a false flag?

Consolidation, then resume up trend

When the 50-day moving average moves sharply up through the 200-day moving average, it indicates strong momentum. Sometimes this can lead to short-term overbought situations. Technical charts often reflect these cases in periods of consolidation, sideways trading, or partial retracement. This is the key moment. If the asset price trend is changing, the buyers will eventually regain control, moving the asset price to higher ground.

Many traders make the mistake of buying too early. The critical error here is to buy before the uptrend has been confirmed and the period of consolidation is over. If you invest too early, you may encounter a pullback towards the 200-day moving average. This may lead to a retracement below the trendline. There is an easy way to tell what degree of risk traders are willing to take. It depends on whether they wait and see the trend’s confirmation after what they expect to be a consolidation period.

Example of a Golden Cross

Next, we will demonstrate a Golden Cross and how the trend may progress. To that end, we will use the E-Mini S&P 500 Futures as an example. Let’s look at the chart below. The green line (indicating the 50-day moving average) moved up through the blue line. The latter indicates the 200-day moving average) in July. At that point, the index went into a period of consolidation. Afterward, it briefly fell back below the 50- and 200-day moving averages. However, while the 50-day moving average remains above the 200-day moving average, we consider the trend intact.

As you can see from the shaded area, the index rebounded relatively quickly after dipping below the 200-day moving average. It was only in late October/early November that the Golden Cross was confirmed. While investors going long on E-Mini S&P 500 Futures would eventually have made money, buying any time during the period of consolidation, this would have been something of a gamble.

Once we could confirm the change in trend towards the end of the area marked by the box, this resulted in a significant upward movement in the index. Even though this period of consolidation/sideways trading is perhaps more elongated than normal, it does highlight the various stages of a changing trend.

What is a Death Cross?

In simple terms, a Death Cross is the exact opposite of a Golden Cross. It indicates the weakening of a positive trend and the emergence of a bearish trend. Very often, due to growing short-term downward momentum, this can lead to a short-term oversold situation. It is not uncommon for the index level to rebound on or around the Death Cross date. Much like an overextended elastic band snapping back, this is all part of the Death Cross process. However, it can prompt some inexperienced traders to discount the signs of a potentially changing trend.

Example of a Death Cross

The following chart perfectly illustrates the various stages of an emerging downward trend. In particular, you should take a close look at the area in the box. As you will see, the index had been stuck in a trading range for some time before the sellers took control, pushing the index lower. Interestingly, the crossover period came just after a sharp sell-off. There was then a few days of consolidation, another sharp sell-off, and then another period of consolidation. 

Experienced traders would have waited until confirming the emerging downtrend towards the end of the shaded area. Yes, they would have missed some of the earlier downturns, but the trend would have, in their eyes, been all but certain. Consequently, this led to a 300+ point fall in the E-Mini S&P 500 Futures and a relatively quick recovery. The market reached its bottom at around 2340. The recovery was fairly strong. However, there was still more than enough opportunity to make a significant return on a short E-Mini S&P 500 Futures position.

How to Trade the Golden Cross and Death Cross

There are very few technical traders who would depend upon one technical indicator by itself. The above Golden and Death Crosses are prime examples of why it is dangerous not to consider other indicators. The swift rebound would have caught out many traders. That said, these two particular indicators have been impressively accurate when it comes to highlighting changing trends in E-Mini S&P 500 Futures. The following index chart, using 50-day and 200-day moving averages, perfectly reflects this:

To offer a little more balance to the argument, on the whole, the period covered during this chart takes an extremely bullish time for the S&P 500 index. Sentiment as ever seemed to err on the side of optimism rather than caution.

Golden Cross Trading Strategies

As we mentioned earlier, very few disciplined technical traders will only consider one indicator when looking at their next investment. We know that the Golden Cross is a powerful buy signal once we can confirm the trend. However, how does this all fit in with a trading strategy?

When to commit to an investment

There are very few Golden Crosses or Death Crosses where short-term pullback and consolidation periods do not follow. The above chart is a good example of that. Traders will always look for confirmation the trend has changed rather than slipping back into the previous range, but at what point do you commit your investment?

Using additional technical indicators

As soon as you see a potential Golden Cross or Death Cross, it is worth looking at other technical indicators. Since these cross technical events are based on moving averages, they can be relatively late, albeit powerful, indicators of a changing trend. It may therefore be useful to take other technical indicators into account. Examples include the Stochastic Oscillator, Bollinger Bands, Moving Average Convergence Divergence, and the Relative Strength Index. That’s just to name but a few. 

Don’t forget stop-loss limits

While technical indicators are handy for those looking to trade short, medium, and long-term futures, it is still advisable to use stop-loss limits. Those looking to invest in a “new trend” before waiting to confirm it are taking a calculated risk. If the trend is confirmed, they will likely have more upside potential, taking a greater risk at a lower level. If the trend fades and the index reverts back to its previous trading range, a stop-loss limit would limit most downsides.

Those who successfully use the Golden Cross and Death Cross in their investment strategies tend to be flexible and ready to react to change. The more technical indicators that support a changing trend, the more you should go with that new trend. However, once the trend is confirmed, it is still not simply a case of buying futures and taking your eye off the ball.

Death Cross Trading Strategies

A Death Cross trading strategy can be useful when looking to protect a profit or take out a short position (or both). In reality, all of the options applicable to a Golden Cross trading strategy are relevant to an emerging Death Cross trend. The only difference is that the trend is moving in the opposite direction. However, some experts have made an interesting observation about the Death Cross. 

In general, the majority of investors tend to take a more optimistic outlook in the longer term. Consequently, when a sharp downtrend emerges, many investors will be looking to “bottom fish” on oversold positions. As a result, we often see a short sharp rebound from oversold positions. This is typically is stronger than the pullback from an overbought position. 

While this is a contentious issue with many investors, skeptics also highlight that sometimes Death Cross trading signals may not be as strong as their Golden Cross counterparts. As an investor, do you tend to look on the upside in the medium to long term? Or are you a realist who appreciates both upward and downward trends in equal measures?

Comparing The Golden Cross vs Death Cross

The concept behind a Golden Cross and a Death Cross is almost identical. The main difference is one is an uptrend, and the other is a downtrend. In theory, there is no reason why either of these respected indicators should be any stronger than the other. However, as we touched on above, on the whole, investors tend to be more upbeat than downbeat, especially in the medium to long term. Even if there are difficult short-term scenarios where markets come under pressure, it is difficult to see any potential upturn. The coronavirus pandemic is a prime example of investors/markets looking to be positive but often finding few reasons to break free from the ongoing skepticism and negative sentiment.

When it comes to trading based on using technical indicators, it is important to stay disciplined. History shows that investors will take profits quicker than they cut their losses. The idea of banking a profit is attractive and brings with it a degree of kudos. The idea of cutting your losses, admitting you were wrong is something that many investors struggle with.

The whole idea of technical analysis led trading is based on making interpretation while assessing probabilities. There will always be a degree of flexibility regarding how you evaluate emerging trends. However, the necessary discipline is something that comes with time and experience. If a trading strategy using technical analysis works in theory, then it should work in practice. However, dealing in real-time with real money brings a whole host of different pressures!

Criticism of the Golden Cross and Death Cross

As Ari Wald, head of Technical Analysis at Oppenheimer & Company, once said:

All big rallies start with a Golden Cross, but not all Golden Crosses lead to a big rally.”

This short sentence says everything about the Golden Cross’s risks and, by extension, the Death Cross. Those who jump in too early before a new trend is confirmed are taking a higher risk, albeit for a potentially higher return. As with any technical analysis type, there will be false flags, and there will be challenges. While many investors prefer to look for “complex” technical triggers, it is important not to ignore good old-fashioned stop-loss limits. 

If you act too quickly before the trend has been confirmed, at least you limit your downside by having a stop-loss limit. How close you place your stop-loss limit to the index and trend lines may prompt you to bail out too early. You need to balance an acceptable loss to your investment and not react to short-term volatility as the trend changes.

Limiting the downside on false flags

As we touched on above, it is important to have stop-loss limits to limit your losses when false flags occur. It was surprisingly difficult to find examples of false Golden Cross flags for E-Mini S&P 500 Futures. Therefore, we have narrowed the moving averages from the 50- and 200-day figures to the 20- and 50-day moving averages. This injects a greater degree of volatility, giving us a few examples of false Golden Flags.

In the shaded area below, you can see that the blue 20-day moving average moves up through the red 50-day moving average towards the start of June 2016. There was a relatively short period of consolidation and then the traditional climb higher, as buyers took control. In this example, the new trend was short-lived and interrupted by a short sharp move down. The index (but not the short-term trend line) crashed through the 20-day and the 50-day moving averages.

In hindsight, this proved to be a relatively short-term downturn with a quick reversal. The short-term 20-day moving average was unable to pull away from the 50-day moving average. We can also see how the two lines converged in early July. On this occasion, the uptrend was eventually confirmed but not before a period of trepidation and uncertainty. It is worth noting that when the uptrend was eventually confirmed, there was a stronger upward correlation between the two moving average trend lines. 

When the short-term moving average threatened to break back down through the longer-term moving average, the 50-day moving average was relatively steady during the period of concern. Only when the two trend lines began to move in the same direction did the index rally begin to gather real momentum.

False Golden Flag (20- and 50-day moving averages)

The traditional Death Cross flag is also fairly reliable when using longer-term moving averages, so we have added a degree of volatility to highlight a false Death Cross flag. Using the 50-day and 100-day moving averages, you can see that the 50-day moving average briefly dipped under the 100-day trend line in November. However, there is a fairly quick recovery in the index, which continues the long-term uptrend/new trend, depending on your perspective.

This chart also shows a particular aspect of technical trading that can reduce the Death Cross flag’s effectiveness. You will see that just before the false flag, there was a consolidation/sideways trading period. Consequently, a relatively sharp fluctuation in the index would have a greater chance of creating a false flag. In reality, very few technical traders would commit to a new position until the emerging Death Cross had been confirmed. The dip was relatively short-lived, as you can see from the shaded area. It was also nowhere near as definitive a signal as the majority of investors might require.

False Death Flag (50- and 100-day moving averages)

Interestingly, we were forced to inject a greater degree of volatility to find false Golden Cross and false Death Cross flags for the E-Mini S&P 500 Futures chart. This chart perfectly illustrates the additional momentum behind a changing trend. It shows us how the two moving average lines move in tandem.

Final Thoughts

There are a number of factors to take into consideration with regards to the Golden Cross and Death Cross technical indicators:

• Many investors tend to err on the side of optimism in the medium- to long-term, which can create a greater focus on the Golden Cross.
• It is important to find a balance between waiting for a changing trend to be confirmed and missing out on the initial leg of a new trend.
• Since these technical indicators are based upon moving averages, by definition, there will be a lag between day-to-day index movements and the emergence of strong indicators.
• While potent indicators, Golden Crosses, and Death Crosses should be considered in conjunction with other reliable technical indicators.
• Successful investors will also incorporate a stop-loss strategy into all of their investment decisions. Reducing your downside while maximizing your upside is the key to successful long-term trading.

Golden Crosses and Death Crosses don’t occur as often as many other technical indicators. Even so, they can be compelling when they do emerge. Many would argue that Golden Crosses are more lucrative due to investors being more prone to bullish long-term sentiment. The beauty of such indicators is the fact there will always be scope for discretion amongst investors. Some may be willing to take excessive risks at the early signs of a change in trend. Meanwhile, others may prefer more solid confirmation, which could reduce their potential profit.

Whatever you believe about these two technical indicators, the proof is in the pudding. The above charts show some powerful signals in years gone by.

The post How to Use The Golden Cross and The Death Cross in Trading appeared first on Earn2Trade Blog.

What are Futures?

As the term suggests, a futures contract is an agreement to buy or sell an asset at an agreed date in the future. It is possible to trade futures contracts on anything from coffee beans to iron ore, precious metals to oil, cryptocurrencies to market indices, and more.

There are three types of parties active in the futures market:

• Those looking to sell an asset for commercial reasons
• Those looking to buy an asset for commercial reasons
• Investors/speculators

Each futures contract is based on a standardized structure which includes the following parameters:

• Unit of measurement
• Type of settlement (physical delivery or cash settlement)
• Quantity of goods in the contract
• Physical contract currency
• Futures contract currency
• Grade of product where applicable (for example, metals)

This standardization of futures contracts means that those investing or speculating in different futures markets know what to expect.

Futures Offer a Very High Leverage

The subject of leverage is most certainly a double edge sword. When the market moves in your favor, you can create spectacular returns. However, the exact opposite is true if the market moves against you. The degree of leverage achieved by the futures market is directly related to what is referred to as “margin.” This is the degree of capital you need to hold on deposit as a percentage of the value of your futures contract. The exact margin requirement will vary for different types of futures contracts, commodities, indices, etc. Typically, it will be between 3% and 12%.

We will use the E-mini S&P 500 futures contract, the most popular index futures market, as an example. The E-mini S&P 500 futures contract is worth $50 per point as opposed to $250 per point for the full S&P 500 futures contract. This allowed retail investors to trade futures contracts at 1/5th of the value of the original S&P futures contracts. Using a margin of 5%, the calculation for one E-mini S&P 500 futures contract is as follows:

To demonstrate the impact of leverage, we will assume that the S&P 500 index increases by 5% in one day. The following calculations will compare and contrast the impact on profits by trading on margin and trading on cash settlement.

By trading on a 5% margin against cash payment, this has created a leverage of 20 times. Unfortunately, if the market had fallen by 5%, this would have created the equivalent loss. Those are the pros and cons of margin trading.

Futures are Very High in Liquidity

As discussed above, the structure of futures contracts has been standardized. It is, therefore, easier to understand for institutional and retail investors. There are also numerous other factors that contribute to the very high liquidity in leading futures markets:

• Traded on regulated exchanges
• A high degree of transparency
• Security of delivery
• Highly efficient pricing
• Ability to trade in large volumes
• A mix of commercial/speculative investors

While some non-market participants are often critical of speculative investors, in many ways they enhance the degree of liquidity in leading futures markets. In what can become a self-fulfilling prophecy, greater liquidity will attract day traders, which will improve liquidity and attract more traders.

If we look at the oil futures market as one example, this gives access to the oil price, which would be difficult to replicate by exposure to individual oil companies. Consequently, large institutional investors looking to increase their exposure to the oil sector will often use the futures market rather than stocks or traded options. 

It would be wrong to suggest there is limited liquidity in the index traded options market, but as this is often spread across different delivery dates and strike prices, the degree of liquidity is not as in-depth as in the futures market.

To put this into perspective, let us look at the value of average daily trades in the E-mini S&P 500 futures contract and Apple shares:

Apple is one of the most heavily traded stocks on the S&P 500. This demonstrates the huge difference in trading values. The value of daily traded E-mini S&P 500 futures contracts is approaching 30 times that of Apple shares.

Commissions are Lower in the Futures Market

Historically, the commission charged on trading futures has been significantly lower than that for stock and traded options. While there will be a charge made by the exchange on which the contracts are traded, this is minuscule and based more on volume. As contracts such as the E-mini S&P 500 futures currently trade at in excess of $200,000, the effect of gearing has a much greater impact on returns than rates of commission. Some companies will only charge when the futures position has been closed, while others will charge a reduced fee on opening and closing trades. 

The situation has become a little more complicated of late, with some online brokers offering cheap execution-only stock and traded option services. Investment commission tends to be structured in two ways, set fees for high net worth traders to a tiered structure for volume-based traders. There are still some extremely competitive commission rates available for futures traders, and it is important to do your research.

Assets are less Susceptible to Insider Trading

The subject of insider trading involves non-public information which may or may not impact the value of an asset. As the more popular futures markets tend to concentrate on asset classes as opposed to individual companies, they tend to be less susceptible to insider trading. Consequently, the value of futures contracts is seen by many as more transparent than individual stocks. This attracts a greater degree of confidence, and confidence leads to increased volume.

The movement in an index for example will reflect the movement in the underlying constituents of the index. The movement of a stock price or a stock traded option will reflect the movement of an individual company and is, therefore, more susceptible to insider trading. Regular examples of insider trading tend to revolve around corporate activity in areas including:

• Contract wins
• Takeovers and mergers
• Company results
• Financial issues

We have also seen instances of insider trading when it comes to oil futures and OPEC meetings, interest rate changes, and leaked economic data, but these tend to be less common. If you are looking to align your investments with a particular index as opposed to one or a group of companies, index futures are seen by many as more transparent.

No Restrictions for Short Selling

When looking at futures contracts, stocks, and traded options, the process of short selling is very different. 

Futures contracts

There are no restrictions when it comes to short-selling futures contracts. You would simply be trading on the margins, for example, 5% with the E-mini S&P 500 futures, with the exact amount depending on movement in the underlying asset. This is a very quick and very efficient way to short a particular asset, more traditionally an index. Long and short positions in index futures contracts have created extremely liquid markets. 

Traded options

Traded options consist of calls, the option to buy, and puts, the option to sell. Consequently, if looking to short a particular asset, either buy a put or sell a call option. When going short, the margins are much higher than futures contracts, often up to 20%. When buying put options, you will pay the full option premium (including time value). Depending upon the asset, there may be liquidity restraints not experienced in the futures market.

Stocks

If looking to short sell a stock, you would need to borrow the stock to hold as collateral. Stock can be borrowed from third parties but not only is there a borrowing cost, there is also additional margin to pay. As some stocks are more liquid than others, you may have difficulty buying sufficient stock at the right price. 

When selling futures contracts short, you are trading at the spot price. Therefore, there are no additional charges or time value involved.

The market is open nearly 24 hours a day

While stock markets around the world open and close at different times, in reality, financial markets never sleep. As the US closes, Japan is about to open. When Japan closes, the UK is ready to begin trading, and the circle continues. The trading times for stocks and stock options markets will mirror the times for the local market. For example, the US stock traded options market is open during normal US trading hours. However, the situation is very different when it comes to futures!

In essence, futures markets such as the E-mini S&P 500 and other leading indices can be traded 24-hour was a day, five days a week. This means that the opening bell for the S&P 500 will reflect futures contracts activity outside of traditional market opening hours. You will often see market observers highlighting changes in futures contracts as an indication of how the market will open. How does this help investors?

Let’s assume that you were long on the E-mini S&P 500 futures, and there was a significant economic/political announcement outside of the US market hours. Between Monday and Friday, 24-hour was a day, you would be able to trade your futures contract and therefore react there and then. If you hold stock or stock traded options, you would not be able to react to news outside of traditional market hours. Consequently, when the markets opened, the opening stock price/traded option price would already reflect the earlier news. Too late for you to react!

You don’t need a lot of money to get started

The key to futures trading is, as covered above, the degree of leverage created by trading on margin. You obviously need to take a cautious approach to over-leveraging your positions, but there is potential to start trading with as little as $500 in your account. However, this is only part of the equation.

While some smaller futures brokers will allow you to open an account by depositing just $500, others may require $5000 or more. On top of the relatively small amount needed to open some accounts, you will also need to consider the margin requirement on different futures contracts. Some of the relatively small foreign-exchange micro-contracts will require a margin of less than $1000. However, some of the larger contracts, such as the E-mini S&P 500 futures contract, will normally require a margin of around 5% – circa $11,000.

Even though there is a degree of leverage when trading options, this is much less than that available with futures contracts. Consequently, the equivalent margin call would be greater. While it is possible to trade stocks on margin, the degree of leverage is again much less than futures trading. 

How much do you need to start trading?

While it is possible to start trading with just $500, this should be seen as part of your learning curve, not a road to riches. Once you understand the markets better, how certain contracts work and how to protect your investment going forward, you can then consider increasing your investment and exposure.

It is important not to “put all of your eggs in one basket” when starting with a relatively small investment pot. Take your time, limit your downside and maximize the upside while, more importantly, learning lessons along the way. We have a very useful blog post entitled “Get started with $500,” which will explain the process of beginning your investment career with a relatively low deposit.

Futures are a Great Diversification Option

Many investors often overlook the diversification opportunities created by futures contracts. While each futures contract is a reflection of one asset price, if we look at the E-mini S&P 500 this offers indirect exposure to the 500 individual constituents. The cost and time constraints in trading each individual constituent would be extremely inefficient. On the flip side of the coin, if you believe that the S&P 500 index is about to fall, you could sell a futures contract and buy back at a lower price.

If you also take a step back and look at the wider picture, in an instant, you could have exposure to all of the major worldwide indices, oil, metals, commodities, and any other asset class where futures contracts were traded. In a scenario where you believe that the oil price is due to increase in the short to medium term, you may be tempted to buy oil companies. However, what do you go for, the majors, exploration companies, or the midmarket providers?

Using oil futures, you would simply be able to buy into the oil price with the hope of selling at a higher price when your prediction comes true. This reduces the risks associated with exposure to one or a small number of companies and ensures that you benefit from any increase in oil prices.

Futures contracts also allow you to hedge against potential falls in the market which would impact your existing portfolio. By effectively selling futures contracts, this will protect your existing portfolio with, in theory, the profit on futures trading offsetting the reduction in the value of your investment portfolio. The use of futures contracts as hedging is akin to an insurance policy, creating a significant element of the huge liquidity we see today.

Futures Offer Attractive Tax Benefits

When looking at futures, stocks, and options in this article, we are predominately considering short-term investments, less than 12 months. This brings into play the 60/40 rule, which differentiates short-term stock/ETF capital gains compared to future contract/traded options gains.

Future contracts

Under current US legislation, short-term capital gains from futures trading come under the 60/40 rule. Consequently, 60% of the gain is taxed at the long-term capital gains tax rate of 15%, while only 40% is taxed at the individual’s income tax rate.

Stocks and ETFs

Short-term gains created by investing in stocks and ETFs are not considered under the 60/40 rule. Instead, investors will be taxed at their ordinary income tax rate on any capital gains.

Traded options

Under normal circumstances, the short-term trading of options should see capital gains assessed under the 60/40 rule. The situation is complicated when individuals take up the option to acquire stock and sell after one year. In this instance, it is important to take advice.

There are significant benefits when trading options or futures contracts, which would fall under the 60/40 rule, as opposed to stocks and ETFs. The long-term capital tax rate is approximately half of the short-term capital gains rate (the individual’s income tax rate).

No Pattern Day Trading Rules

Under SEC regulations, traders/investors executing four or more day trades over five business days, using a margin account, will be classified as Pattern Day Traders (PDT). Consequently, they will be required to deposit $25,000 into their margin accounts. If the margin account balance falls below $25,000, their dealings will be restricted until further funds are deposited. These regulations relate to securities and stock options. However, futures contracts and futures options are not part of the SEC day trade rule.

There are obvious liquidity benefits for those using futures markets as a means of gaining exposure to various indices and assets.

Access a Wide Variety of Assets

It is only when you begin to look in-depth at futures markets that you realize the huge variety of assets covered. This includes:

• Index futures
• Currency futures
• Commodity futures
• Interest rate futures

Aside from index options, traded options are irrelevant for many of these markets. While the majority will have some form of a cash market, if you are acquiring commodities, you will also experience an array of additional charges for storage, etc. The efficiency and the deep-seated liquidity of the leading futures markets continue to attract new business.

One very recent example of the fast-moving nature of futures markets was the introduction of Bitcoin futures onto the Chicago Mercantile Exchange (CME). This comes at a time when many regulators around the world are attempting to block direct investment in cryptocurrencies by retail investors. Consequently, the option to trade in cryptocurrency futures offers an ideal, regulated, means of gaining exposure to that market.

No Need to Worry About time Decay

The issue of time decay is very important when comparing futures contracts and stock purchases with traded options. Futures contracts and stock purchases are traded at what are known as “spot prices” which is the price at the time of the investment. An option price is made up of two elements:

• Time value
• Intrinsic value

The intrinsic value is the difference between the strike price and the price of the asset at the time. So, for example, if you have the option to buy shares in XZY Company at $20, and the current price is $25, the intrinsic value is $5. If you have the option to buy the shares at $20 over the next three months, you will pay an additional time value premium. Let’s say the option was trading at $6. This would equate to a $ 1-time value and $5 intrinsic value.

If, in three months, on exercise day, the stock was still valued at $20, then each traded option would be valued at $5. This is because the value of the three-month period in which you could acquire the shares has deteriorated; there is no element of time value. As the value of futures contracts and stock investments are directly related to the underlying assets at the date of purchase, with no time value as such, there is no time decay.

Get Into Futures Trading Today

While it is obviously important to do your research before contemplating trading futures, nothing beats the hustle and bustle of “real-time” investment. We have an array of informative articles explaining futures trading, futures contracts, and the options available to you. We also have the “Trader Career Path,” which is an evaluation on a virtual futures trading account based on real-time prices and real-time movements. The chance to dip your toe into the futures market and feel the pressure, even though you are trading virtual funds.

The Trader Career Path offers the opportunity to flex your muscles and prove your trading skills over the duration of your subscription. The analysis of your trading results takes into account your investment returns but also your attitude to risk. It is the ability to de-risk your investments while maximizing the returns which will stand you in good stead. Those who can pass the test based on its rules and objectives are offered a funded trading account, a stepping stone to a long-term investment career.

Contrary to popular belief, while investment in futures contracts is seen as riskier than stocks and options, it is all about minimizing the downside and maximizing the upside. Stop-loss limits, trading strategies, and the like are used to protect investment capital, effectively cutting your losers and running your winners.

The post 12 Reasons To Trade Futures Over Stocks and Options appeared first on Earn2Trade Blog.

When it comes to trading, we bow to the words of the legend that is Kenny Rogers:

“You’ve got to know when to hold ‘em, know when to fold ‘em, know when to walk away, know when to run”.

Stop-Loss Order Types

There are two types of stop-loss orders. These are the are sell-stop orders and buy-stop orders. In effect these are two sides of the same coin allowing traders to protect both long and short positions. In many ways this strategy takes the emotion out of trading. When the contract hits a certain level, BANG, your trade is executed. No second thoughts, no backtracking, done!

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Sell-Stop Orders

Fear and greed dominate investment markets. They often cloud the judgement of investors striving to lock in that last dollar of profit. These emotions can also prick the ego of traders going against the market. Especially when they’re unwilling to accept they may have got it wrong. A sell-stop order strategy is a very basic strategy. If the contract falls below a particular level this will trigger a sale at the prevailing market price. There is also a major downside. In fast-moving markets the actual execution price could be very different to the sell-stop limit level. It is probably easier to show an example of this strategy in action….

Sell-Stop Order Examples

In recent times, we have seen extremely volatile markets. This has caused immense activity on the E-mini NASDAQ-100 Index (NQ) futures. As you will see from the one-month and the six-month NASDAQ-100 Index graphs below, this volatility has presented a number of short/medium term trading opportunities. If we put aside the gearing impact of futures contracts and look at the index movements in isolation there have been numerous suitable occasions to use sell-stop orders to protect profits.

The six-month graph highlights an uptrend from 18 December (8580.62) to a peak on 19 February (9718.73). That equates to a 1100+ point move. Continuous adjustment of a stop-loss limit may well have seen a sell-stop order prematurely activated towards the end of January. Most likely when there was a short-term dip (9216.98 to 8952.18) but even that would still have produced an impressive profit.

Those with a long-term outlook may have been more cautious with their stop-loss limits, retaining their position until the peak of 19 February (9718.73). The market began to turn on the 20 February and in a worst case scenario a sale would probably have been activated on the 21/24 February. This would have allowed the investor to crystallise a very healthy profit before an even greater collapse. So, whether maintaining a tight or wider stop-loss limit, investors using this approach would have crystallised large profits and avoided the worst of the 2700 point fall to 20 March.

Example Outcome

On the flipside of the coin, as you can see above, the collapse of the NASDAQ-100 between the 10 and 11 June (a fall from 10,094.26 to 9588.48) would likely have wiped out much of the short-term gains (flipping positions to a loss) from the previous uptrend. Unfortunately, due to the speed of the market collapse a sell-stop order may have seen futures contracts sold at a huge discount to the previous evening’s close and the prevailing stop-loss limit. Sell-stop orders work best in less volatile markets but you would not normally expect a 500 point fall on an index during a 24 hour period! However, in many ways this highlights a major downside for stop-loss orders.

Buy-Stop Orders

If we look at the six-month there have been numerous opportunities to short the NASDAQ-100 index using E-mini NASDAQ-100 Index (NQ) futures. On the 19 February the market peaked at just over 9700 then began a downtrend which would bottom out at less than 7000 on 20 March. Imagine you had taken a short position at the peak – how might this have panned out? In all likelihood the serious volatility in the following days would probably have triggered the stop-loss limit of even the most adventurous of short traders. However, even a buy-stop order triggered on 27 February, the first market bounce, would still have benefited from a near 1300 fall in the index.

Those who maintained a position when the market bottomed out at just below 7000 on 20 March would have seen their stop-loss limits triggered fairly quickly when the market bounced. The beauty of using a buy-stop order, to protect a short position, is perfectly reflected in the fact that the index hit a new all-time high at just under 11,000 on 10 June 2020. This no-nonsense approach using buy-stop orders takes away the decision-making process when these triggers are breached.

This table gives you a basic idea of the differences between sell-stop and buy-stop orders:

To get a clearer understanding of both strategies, let’s take a look at the following comparison table:

Stop-Limit Orders

Some people may see stop-loss orders and stop-limit orders as one and the same. They’re not, there are some very subtle but very important differences. With a stop-loss order, when the contract price hits that level a trade is triggered and executed at the prevailing market price. A stop-limit order is a two-stage affair with the initial price activating a stop-limit order and a second (minimum) price limit – allowing traders a degree of control over the actual transaction price. This ensures that in fast-moving markets, or sharp movements in contract prices on the open, investors are not committed to a sale at any price. Let us look at how this works in practice.

Stop-Limit Order Example

The above scenario is a good example of a stop-limit order working to the benefit of an investor:

“The collapse of the NASDAQ-100 between the 10 and 11 of June would likely have wiped out much of the short-term gains (likely flipped the position to a loss) from the previous uptrend. Unfortunately, a sell stop-order would have seen futures contracts sold at the open on 11 June. Probably at a huge discount compared to the previous evening’s close and prevailing stop-loss limit. Sell-stop orders work best in less volatile markets. The reason is that you would not normally expect 500 point fall in the index overnight. However, in many ways this highlights a major downside stop-loss orders“

Let us assume that a trader acquired futures contracts when the market stood at 9331.93 on 18 May 2020. This uptrend ended abruptly on 10 June 2020. That day, June 11th 2020, the market fell from 10,094.26 down to 9588.48. A fall of more than 500 points. Moving a stop-loss limit higher and higher as the market rose from 18 May to 17 June let’s assume there was a stop-loss at around 9900. Even outside of trading hours it is likely the markets moved so quickly it would have been difficult to activate a stop-limit order and carry out any transactions within say a minimum level of 9800. This would therefore leave the position open. Using stop-loss orders, as mentioned above, the position would have been liquidated much lower with no control over the transaction price. However, the situation with a stop-limit order is very different.

How It Works in Practice

The investor could leave the 9800 minimum limit active which would result in the futures contracts being sold when the index hit this level – on the way back up. Alternatively, they could have reassessed the situation and made changes to both the initial activation level and the minimum price for any resulting sales. Using the one-month graph for the NASDAQ-100 we can see that between the 16and 17 June the index passed back through the 9800 minimum sale point. So, while the stop-loss order transaction could have been liquidated on an index level as low as 9588.48 the stop-limit order would have benefited from the gradual recovery over the three days following the sharp correction.

The use of a stop-limit order worked perfectly in this scenario. Conversely, if the markets had continued to fall there is no telling when the index would eventually, if ever, have reached the original 9800 minimum sale point.

The same type of strategy is also used by short sellers looking to buy back contracts to close open positions. However, there’s a downside. If a purchase could not be completed within the limit price range then there is a risk that the market would continue to rise. That leaves an open-ended liability on the open position.

Which one should you use and why?

There is no one size fits all when it comes to stop-loss/stop-limit trading strategies. Allthough, there are ways of mitigating potential dangers for different strategies. Let’s take a look at how each strategy might impact short-term traders and long-term investors.

Short-term traders

Short-term/day traders have one thing in common, they tend to cut their losers fairly quickly and run their winners. As they focus on relatively volatile contracts, sell-stop orders tend to be the preferred strategy and the pricing can be relatively tight. This will see losing trades jettisoned fairly quickly to focus on those moving in the right direction. Short term traders tend to have little interesting in medium term contract recoveries therefore even a quickfire sale below their initial stop-loss limit would not be the end of the world.

Long-term investors

By their very nature, long-term investors take a more long-term approach to their investments. As a consequence are perhaps more suited to the stop-limit order strategy. They will often have a target index level in their mind. Assuming the fundamentals don’t change they may be happy to wait. That is not to say that they won’t continuously reassess the prospects for their investments, but they are less susceptible to short-term, often volatile, price movements. They tend to trade on the philosophy that fair value will prevail in the end.

Advantages and Disadvantages of Stop-Loss Orders

There are various advantages and disadvantages when using stop-loss orders and stop-limit orders which include:-

• Stop-limit orders offer a degree of protection from extreme price volatility
• Stop-loss orders can limit further downside especially in fast-moving markets
• Stop-limit orders guarantee a minimum price but no certainty of executing a trade
• Stop-loss orders guarantee a trade but no certainty of price
• The greater the gap between the stop-limit price/minimum price the more chance of executing a trade
• Relatively low stop-loss order prices can protect against short-term volatility
• Stop-limit orders allow investors to reconsider their position if the limit price was missed
• Stop-loss orders are final and definite, no room for emotive decision-making

Stop-Loss vs Stop-Limit Orders F.A.Q

Hopefully we have covered the vast majority of questions you may have regarding stop-loss orders and stop-limit orders. However, the following questions have been asked on numerous occasions:

The post Stop-Loss vs Stop-Limit Orders – What Is The Difference Between Them? appeared first on Earn2Trade Blog.

What are Fibonacci Retracements?

Let’s start with a brief bit of history. Going by the name, you would think that Fibonacci was some famous Italian artist or musician. In reality, he was neither. He was actually a mathematician born in 1170. His original name was Leonardo of Pisa. He only earned the name Fibonacci post-mortem, often credited to historian Guillaume Libri. The name was a portmanteau of filius Bonacci, meaning son of Bonacci.

It is fair to say that Fibonacci’s numbers theory attracts a great deal of controversy among traders. The ones who advocate for it argue that these numbers are spontaneously replicate in nature, architecture, and many other areas of life. This suggests that the patterns they form have an inherent meaning. We can apply them to trading as well. The typical counter-argument is that this is simply a function of mob psychology. When enough traders believe these numbers to be meaningful, that can shift the entire market if they act on it simultaneously.

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The Fibonacci Sequence

The actual Fibonacci sequence is 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89 and so on. Basically, each new number is the sum of the two previous numbers. So how do these numbers give us the Fibonacci retracement levels? As the sequence goes on, each number gets closer and closer to 61.8% of the next number. That’s how you get the first retracement level: 55/89 = 61.8%. The second level is any number divided by the second number to the right. For example, 34/89 = 38.2%. The third level is dividing by the third number to the right, i.e., 21/89 = 23.6%.

Going by that logic, dividing 1 by 1 gives you 100%, and 1 by 2 is 50%. That makes 100% and 50% relative retracement levels as well. When you line the numbers up, you’ll see an almost symmetrical sequence. However, something is missing.

To make it completely symmetrical, we’ll need to add one more retracement level. Subtract 23.6% from 100% to get our final retracement level at 76.4%. The final sequence should look like this:

Now that the sequence is complete, it’s time to ask whether these percentages have any real value. Whether you’re looking at the shape of a snail’s shell, flower petals, the leaves or branches of trees, or even the reproductive pattern of rabbits, you will find the Fibonacci sequence repeating time and time again. Given that it’s so commonplace, why not try applying it to trading?

How do Fibonacci Retracements Work?

We have added the various Fibonacci retracement lines to the chart below. As you will see shortly, there is a method to this madness. The idea is simple: on the way down, the Fibonacci retracement lines act as support lines. Conversely, on the way up, they are a form of resistance. Let us say, for example, that price was to crash through support at the 23.6% retracement line. The next powerful line of support will be at the 38.2% retracement line. Then, it is 50% until full retracement back to the original swing low level. As you will see with the E-Mini S&P 500 Index chart, the trendline support keeps growing. Instead, it falls. What we end up seeing is the trend getting increasingly stronger.

There will obviously be occasions where a fall is temporary and merely a rebalancing of bears and bulls. This is similar to when you pour additional water into a container and the surface ripples until it calms down. This is a natural mixture of different investors. On the one hand, you have those taking their profits from investments at the lower levels. On the other, there are those looking to jump on board the uptrend but still waiting for a short-term retracement. Many traders will also use the various Fibonacci retracement levels as stop-loss limits or a means of protecting profits. Typically the trend does seem to be changing.

How to Calculate Fibonacci Retracements?

Let’s use the chart above as our basis for analyzing the Fibonacci retracement tool. As you will see from looking at it, it is all based around the swing low and the swing high. In the example above, the swing low for the E-Mini S&P 500 index is 3126.25. The swing high is 3169.25. Both of these figures are shown in the white boxes. The retracement factors for the Fibonacci theory are as follows:-

• 23.6%
• 38.2%
• 61.8%
• 76.4%

If we take the difference between the swing high and the swing low (3169.25-3126.25), we get a gap of 43. This is when we turn to our trusty spreadsheet to do the calculations for us. So let’s simply apply the retracement lines from earlier to the chart above. That’ll give us the following numbers:

• 3159.00
• 3152.50
• 3142.50
• 3136.25

At this point, we can recognize that the graph is starting to get a little crowded. Even so, many traders will still add an additional trendline at 50%. In this example, it is 3147.75. It all looks very technical, but what exactly does it mean? Should we be buying at the trendline or selling at the trendline? Maybe monitor its price until others dictate the direction? This is where the whole concept of the Fibonacci retracement theory is challenged.

How to Use Fibonacci Retracements

The E-Mini S&P 500 Index graph perfectly illustrates how to use Fibonacci retracement to enhance your trading strategies. It is worth noting that although many traders use Fibonacci levels to consider their next move, they won’t stop there. They may also take into account the longer-term trends. These can, in some cases, strengthen the argument for using Fibonacci retracements. So, let’s look at how traders may have done well during the above period of relative volatility.

Applying it in Practice

In this case, you can see the swing low level at 3126.25. Then, the swing high at 3169.25. This gives us our actual range of 43. When the index hits the short-term high, we immediately calculate the various Fibonacci retracement levels. Interestingly, there is strong support at the 23.6% retracement level. That leads to a relatively tight trading range in the early days after the high. You can see occasions where the index dipped below this support level. However, it then bounced back from the 38.2% retracement trendline. So far, so good.

A relatively short period of stagnation between the first/second trendlines and then suddenly turned into an uptrend. The index burst through the 23.6% retracement level (initially a support line), which was now a resistance. What many would describe as a period of consolidation then turned into a resumption of the previous uptrend. Where would it end? It is fascinating to see that once a peak of 3169.25 had been met, there was a limited appetite to push the index into new territory. The index started to turn downwards, the trend was changing, and it quickly began to crash through support levels. There was a limited degree of support between the first and second Fibonacci retracement levels. Even so, it was a powerful downtrend. We could see the index crashing through one support level after another.

The Full Retracement

While not as uncommon as many people might assume, we saw a full retracement back to and even below the previous swing low level (100% retracement). The fundamentals had obviously changed, and investors were running for the hills. The reason being that there was minimal support on the way down. Even after crashing through the 100% retracement level. Take a look at the right of the chart. You will eventually see a partial recovery. We can observe strong evidence of the Fibonacci retracement levels proving to be both resistance and support. Fascinating stuff!

How to Use Fibonacci Retracements With Price Action

Incorporating Fibonacci retracement levels with price action has been extremely lucrative for many traders. In simple terms, investors will first focus very closely on the Fibonacci retracement levels. Then, they’ll incorporate their own opinion. In many cases, this is based on historical price movements, resistance, and support. No matter how technical your trading strategy gets, it’s difficult to completely avoid getting your ego involved.

There are many factors to consider when using price action. Especially when analyzing the many trends, we see repeated time and time again. One of the more common trends revolves around the 50% retracement level, which can occur for several reasons:

• The index is simply overbought
• Profit takers gain control dragging the index down
• Over exuberance
• Buyers take control at the 50% retracement level

Many of you will be reading this passage with a degree of skepticism. Maybe even downright disbelief. If you still have your doubts, let’s take a look at the next chart:

The 50% Retracement

Let’s take a look at the point where the index bounced. It happened at the 50% retracement between the initial swing low at 3035.25 and the swing high at 3074.75. Moving towards new higher levels, the swing high very quickly became a support level. The whole concept of the Fibonacci retracement theory is based upon a maintained trend. If you see an index moving higher very quickly, there is a good chance you will see natural retracement at some point. However, the trend might still be intact. As we mentioned above, human nature suggests those with large paper profits will look to protect these profits. On the other hand, those who missed out on the initial uptrend may feel that the 50% retracement gives them the perfect buying opportunity. They don’t want to miss out again, and in this case, that’s the correct choice.

Have you ever wondered how many other traders are waiting to buy the same price level that you are? Let us say, for example, in the case of a 50% retracement from a relatively short-term spike in any asset/contract. Just look at the case above. Once the 50% retracement was complete, the bulls took over, and there was a relatively short sharp upturn. It was a deluge of buying orders, pent-up demand, or whatever else you like to call it. The point is, the rebound from this support level was robust. It did not just continue the initial uptrend, either. Tt was actually strengthened once the profit-takers had been shaken out.

How to Use Fibonacci Retracements With Long-Term Trendlines

There are numerous ways to incorporate the Fibonacci retracement theory with other types of technical/chart analysis. The use of a long-term trendline with various Fibonacci retracement levels can create powerful signals. As you’ll see below, in this scenario, it is a sell signal.

As you can see, we have plotted a trendline from the swing low-level crossing the 23.6% Fibonacci retracement level. At this point, it was evident that the support line was about to break. The uptrend that began at the swing low was also at risk due to the sudden market downturn. This led to a 76.4% retracement. Then, a degree of support until this failed, and we saw a 100% retracement of the rise.

If you’re still a skeptic, you could point out that we are proving a point in hindsight. Even so, it is plain to see that the uptrend was over when the index crashed through the initial support level and the long-term trendline. You could argue back and forth about whether these lines are viable when trading in real-time. Even so, there’s one thing worth keeping in mind. The majority of traders will have their eyes on both the Fibonacci retracement levels and long-term trends.

Is this a self-fulfilling prophecy or simply a case of history repeating itself, you decide.

Pros and Cons of The Fibonacci Retracement Tool

There are many different aspects to take into consideration when looking at the Fibonacci retracement theory. Such as:-

Does the theory work?

As much as people argue for or against the Fibonacci theory, the fact is, it does repeatedly appear in nature. This is undeniable. Whether the pattern can be translated into asset valuation trends, investment strategies, and, more importantly, human nature is debatable. Are we merely making use of the oldest trend strategy in the world? Or is the support for it amongst traders so intense that it determines the trend itself. In the end, if it helps you make a profit or reduce losses, does it really matter?

Timing is the key

Are you one step ahead of the crowd, knowing that other traders are waiting for the support/resistance level to be breached? Or do you wait until a firm trend has emerged? This is where additional factors, such as long-term trendlines and price action strategies, come into play. They can confirm or undermine the basic Fibonacci retracement level argument.

Selling too soon

In the words of JPMorgan:

“I made a fortune getting out too soon”

What does this mean, and how can you use it? Riding an uptrend is relatively easy in theory. There may be ups and downs and fluctuations, but if the trend remains intact, then run your winners. However, what happens if you sell on the first retracement once it crashes through the 23.6% Fibonacci retracement level? Well, the worst-case scenario is you bank a profit, and you live to fight another day. The best-case scenario is that the breakthrough was an actual change in the trend. That means the 23.6% support line was a precursor to further weakness.

While we mentioned the natural 50% retracement, there is no guarantee that the index will bounce back towards its previous highs. Indeed, the previous 23.6% support line may turn into strong resistance.

How The Fibonacci Retracement Tool Can Help You

Even reading through the theory behind the Fibonacci retracement tool will give you an idea of natural trends. It’s also evident that a large number of traders do take this particular investment strategy into account. You could even argue that as a result of that, it becomes a self-fulfilling prophecy. Even so, it should still be included in your arsenal of trading tools.

The least charitable view is that the Fibonacci traders are nothing more than sheep following the herd. Even so, there’s value in knowing which way the herd is going. Therefore, it makes sense to incorporate at least an element of the Fibonacci theory into your investment strategy. If the support lines are indicating breakout or a fall-through resistance, this might attract your attention. However, what if long-term trend lines have also been broken? You now have two robust indicators suggesting that the trend is changing. There could be a breakout on the upside, or there could be a significant downside in the short term. You can now invest with a little more confidence.

Like so many investment strategies, making the Fibonacci retracement principle work requires you to stick rigidly to the fundamentals.

F.A.Q.

The post What are Fibonacci Retracements and How to use Them? appeared first on Earn2Trade Blog.

What is the Simple Moving Average?

The best way to describe the SMA is a series of different subsets using, in this instance, the closing price of an investment market. Some of the more common SMAs include:

Day traders/short-term traders

• 5-day moving average (light blue trendline)
• 10-day moving average (purple trendline)
• 20-day moving average (green trendline)

As you can see on the graph below, the five-day moving average offers the earliest indication of a potential changing trend. However, the 10-day and 20-day moving average flatten volatility even further to create a smoother trendline. Short-term trendlines can send false signals, while long-term trendlines offer stronger signals, but there is a lag.

Longer term traders

• 50-day moving average
• 100-day moving average
• 200-day moving average

Where the moving average calculation period is extended, the trendlines are much smoother. These tend to be more useful for those looking at long-term trends, avoiding short-term fluctuations that may reduce their long-term gains.

The key to using an SMA strategy is to find the best moving averages for your investment requirements. There is no point looking at long-term trends as a lead indicator, if you’re a short-term trader. On the flip side of the coin, short-term trend indicators are of limited interest to long-term traders.

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Understanding How the SMA Works

Many external factors can impact short-term movement in investment markets, such as the E-mini S&P 500 futures market. This could be a short-term political event, disappointing employment figures, expiry day volatility, or unexpected developments on the international front. Many of these issues will be resolved and forgotten within 24-hours, so the key is not to overreact. What is the best way to achieve this?

Using average prices over a specifically defined period will help flatten the curve and reduce the impact of concise term price fluctuations. That is why short-term traders use five, 10- and 20-day moving averages, while longer-term traders may use 50-, 100- and 200-day moving averages. The key to short, medium and long-term investment success is to ride the trend until it turns. 

As you can see from the above graphs, the longer the period over which the price is averaged, the flatter the line. The longer the period over which you calculate the moving averages the stronger the signal. However, due to the extended time lag, you may already have missed a significant element of the initial change in trend.

How to Calculate the Simple Moving Average

The act of calculating a Simple Moving Average is straightforward. If we consider a trading period of 30-days, we can calculate the five-day moving average. You can do it like so:

Creating data points 

To calculate the five-day Simple Moving Average data points, you do the following:-

The data points will give you an average of the last five days closing prices and allow you to identify changing trends. To calculate a 10-day moving average, simply add together the ten previous closing prices, then divide by 10. The best way to think of this is a flattening of the trendline to be less volatile.

Simple Moving Average Trading Strategy

There are numerous ways in which you can use the SMA to trade short-term, medium-term and long-term. Whether you are trading in futures, companies, metals, or any other type of investment, the principle is the same. Using the following graph, we will now take a look at how you can use Simple Moving Averages to your benefit.

Bullish crossover

A bullish crossover occurs when the share price moves through the SMA into higher ground. As you can see from the first shaded area in the above graph, the first indication of an upturn occurred when the share price moved up through the five day SMA (the blue trendline). This change in trend was confirmed after the index also broke through the 10-day and the 20-day moving average trendlines.

Those looking to acquire futures options on the five-day SMA upturn have the highest potential upside, with significant risk. The risk was that this would be a short-term upturn before returning to the previous downtrend. The 10-day and 20-day simple moving average trendlines, in theory, give a stronger signal, but you may have missed a significant element of the initial upside because of the lag.

Bearish crossover

A bearish crossover is the exact opposite of a bullish crossover. The share price will initially move down below the five-day SMA, then the 10-day SMA, and finally the 20-day SMA. This is a sign that a previous uptrend has turned and, for many, a signal to close an open position or go short. Again, those reacting to the move down through the five-day SMA have potentially greater benefits but more risk that this is only a short-term downturn. A move down through the 10-day and 20-day SMA strengthens the initial indication of a new downtrend.

SMA crossover

In this instance, we know that SMA trendlines the five, 10-and 20-day Simple Moving Averages, indicate a potential new trend. With the bullish crossover and the bearish crossover, the alert to a potential change in trend is triggered as the index level moves through individual trendlines. However, many people also use SMA crossovers as an even stronger indicator that a new trend is emerging.

We have highlighted a number of areas in the above graph where SMA lines have crossed over. If we focus on the initial shaded area, the first sign of an upturn is when the index price moves through the five day Simple Moving Average. However, this change in trend signal is further strengthened as each of the SMA trendlines themselves crossover.

In reality, this is an indicator of growing momentum. The short-term blue trendline moves up through the medium-term purple line, then the long-term green line. It may be that you take out an initial position when the index moves through the five-day moving average and then increase your position as the other SMAs are breached. If you were to wait until the short-term SMA move through the long-term (20-day) SMA, you would have already missed out on a significant element of the upturn.

SMA Advantages & Disadvantages

Simple Moving Average trendlines are an integral part of many investment strategies. While there are numerous advantages, there are some disadvantages, as follows.

When we strip the advantages and disadvantages of Simple Moving Averages to the bare bones, there are a few key points to remember:-

• The shorter the SMA term, the greater the chances of identifying a change in trend at a very early stage. If the signal is correct, then this will maximize your potential returns. However, short-term SMAs are prone to false signals.
• The longer the SMA term, the stronger the change in trend signal, but this will take longer to emerge. Consequently, if depending on a longer-term SMA, you could potentially miss out on a significant element of any change in asset price.
• You need to find an SMA term (or multiple SMA trendlines) that best reflects your appetite for risk and potential rewards. 

SMA vs. Exponential Moving Average

When researching Simple Moving Average investment strategies, you will often come across the term Exponential Moving Average (EMA). The graph below illustrates a 10-day Simple Moving Average and a 10-day exponential Moving Average. While they are both based on the previous ten closing prices, the EMA calculation is weighted. Consequently, more recent price movements will have a more significant influence on the EMA trendline than those at the beginning of the ten days. The longer the EMA period, the less influence historical price changes will have on the trendline.

If you require more information regarding the calculation of EMA figures, we have published an article titled: “Exponential Moving Average (EMA) Explained – Strategies and Tips.”

When researching SMA and EMA investment strategies, you tend to see polarised opinions. The SMA strategy is dependent on reducing the influence of more recent price movements. On the other hand, the EMA strategy gives greater weighting to short-term movements. Many would argue that the EMA strategy is more relevant for short-term traders, looking for very early signals that trends are changing.

Why use the Simple Moving Average?

Whether using a Simple Moving Average, or an Exponential Moving Average, the basis is the same. You are looking to flatten short-term volatility to give a greater insight into short, medium, and long-term trend changes. When looking at a relatively volatile futures price in isolation, it can be challenging to gauge the trend. However, looking at a futures price against staggered Simple Moving Averages will give you an idea of the short, medium, and long-term trends.

Final Thoughts

When looking at a futures price graph in isolation, it can be challenging to identify a short, medium, or long-term trend. It is handy to have five, 10- and 20-day Simple Moving Averages as these give you a basis on which to consider short-term price movements. Long-term traders may use different SMA terms such as 50-, 100- and 200-day. It really does depend on your investment horizon and your appetite for risk/reward.

It is important to note that whatever SMA terms you use will work best in a trending market. A relatively static market does not work well with Simple Moving Averages. Short-term volatility will have a limited impact due to the lack of volatility previously. While the use of EMA terms will give a greater weighting to short-term price movements, in non-trending markets, this impact is also reduced.

On the flip side, if you believe that stock markets are “wholly efficient,” then today’s futures value is the “real value”. Market efficiency is another hot topic!

The post What is The Simple Moving Average (SMA) and How Does It Work? appeared first on Earn2Trade Blog.