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TRACKING THE GHOST OF EL DORADO Daryl Guppy ©1997
As a child I was enthralled by the abandoned rusting hulk of the El Dorado gold dredge stranded on Reedy Creek near Yackandandah and captivated by small clear vials filled with gold dust laboriously panned by an old prospector from mountain creeks in North East Victoria. Despite broken nails, aching muscles, erratic returns, the dirt, dust and heat, I have always found the lure of prospecting for metals and minerals irresistible. Now my prospecting tools are the computer, the stockmarket database, and charting software - and the lure is still irresistible. The dust is banished by air conditioning and only fingers ache from keyboarding. Yet the exploration principles remain the same.
The El Dorado sought by the Spanish conquistadores and described by Diaz
in The Conquest of New Spain did not exist. Ours does. Every day the
market surrenders a rich line of lode to the best traders. I wrote in Share
Trading that we have a choice between a pot of gold and a working gold mine. In
this book I explore some ways of finding the lode and bringing it on-stream to build a
working gold mine. I am not a market wizard so the techniques in this book require no
specialist skills. Like many traders who have moved from working for a wage to trading for
a living, just duplicating my wages is enough to keep me happy. There are fortunes to be
made - and lost - in the market. Better prospectors make, and keep, these fortunes.
This book is written for those who want to survive, and for those who, while not aspiring
market wizard status, would like to more aggressively manage market risk by finding,
exploiting and managing trading opportunities. If you are prepared to pit your prospecting
skill against those who have traditionally held the keys to the market, then this book
will help equip you for the expedition.
Bull market conditions encourage novice traders. In a bull market the market pays for your
mistakes as the general rise in stock prices allows for quick recovery of losses. In a
bear market, you pay for them. Some of what is written in the following chapters may
appear to be unnecessarily complex or detailed, but when the bear bites, these are the
basic disciplines that separate the survivors from market victims.
The processes described in this book are easy in principle but some are very time
demanding if applied indiscriminately. We start with broad selection procedures and as the
list of trading candidates narrows, apply more specialised trading tactics. These
processes build on the routines and approaches covered in Share Trading: An
Approach to Buying and Selling so this book does not cover old ground nor repeat
old material, giving instead appropriate references to Share Trading.
SERIOUS TRADING
Trading is frustrating because, despite all the groundwork required before picking up the
phone to enter, or exit a trade, the market may still slip between your fingers.
Understanding the analysis, being in tune with the market, initiating and completing
scanning processes and fine tuning the financial aspects does not mean a trading
opportunity will be revealed. The market does not owe us a living. Despite the hours of
research, there is no guarantee that the stock will be available at the price we think is
appropriate. There is no guarantee of any real trading opportunities identified by our
painstaking analysis. There may be none that match all our criteria.
This is annoying, but it is only fatal if we settle for second best. As a private trader
we do not have to trade. We can afford to wait until the best opportunities arise. This
protects us from a market indifferent to our existence and survival.
There are always some market situations where the tools of technical analysis appear
useless. This does not diminish the effectiveness of the tools. In the same way that a
carpenter does not use a spanner to build a house, so a trader does not attempt to use
technical tools in trading situations where they offer little help.
As traders we look for those opportunities compatible with the tools we are most skilled
in using. To pretend that our particular tool kit will expose the secrets of all markets,
or of any market segments is foolish. As traders we want to identify our strengths, and
weaknesses. By trading on our strengths, matching our trading style, and using the
appropriate array of tools, we become better traders.
Success does count. Virtuosity is a theoretical skill if it does not wring financial
rewards from trading. Trading approaches which mimic the apparent complexity of the
markets are not always the best at understanding the markets. More difficult does not mean
more accurate. Simple trading strategies score direct profits in complex systems so we aim
in this book to dismember complexity into its simplest components. These lay the
foundation for trading tactics.
A ROAD MAP FOR DISMEMBERING COMPLEXITY
Systems and systematic behaviour are at the core of complexity. Complexity is a dynamical
system positioned on the edge of chaos where a single event - the butterfly effect - could
tip it into dangerous instability and collapse. Survival depends upon the way the systems
adapt to behavioral changes, moving forward along the cliff rather than to one side and
over it.
Trading is on the very edge of chaos, riding alongside the market. Our survival depends on
our ability to define our task and its components to select the right tools and deliver
appropriate solutions.
The core of every complex system has a dominant characteristic. The cyclone is defined by
wind, the turbulence of a waterfall by water, the clash of market activity by numerical
data. We measure the cyclone with an anemometer, the flow of water with a Dethridge wheel
and the market with a price chart. No matter how you make your trading selection -
fundamental, technical, accounting, financial or news analysis - your trading improves
when you know how to read a price chart with its message of probability.
JOINING THE RUSH
Trading with the Balance of Probability, Chapter 1, goes to the core of
every trading approach, matching the message of the chart with its implied information
about probability. When some price combinations occur more frequently than others they
signal a change in probability. The market throws up voluminous data, concealing this
vital information. The cypher of understanding is the bar chart. The price bar, or
candlestick display, is built on clear market emotions pointing to areas of increased
probability. These Message from the Jungle Drums track progress at the
market battle front and save financial lives.
Lassetter’s Reef brings the balance of probability to life in a
sample trade, showing how basic understanding is matched with market reality. This is a
model of the trading nuggets we hope to find and our search begins when we select the best
time frame. Time Bites Character Chapter 4, shows how we focus short,
immediate and long term pictures into a single snapshot. The detail blurs as the structure
emerges. Different time bites are used to confirm analysis across multiple timeframes and
so further stack the balance in our favour.
PROSPECTING FOR TRADES
Armed with an idea of how our trading opportunity might look and how we might recognise it
we are ready to start Searching for True Love at First Profit. Some
traders choose to follow an accounting path. We give them guide information in No
Accounting for All Tastes and explain how their path joins with ours when it
comes to assessing and managing the trade.
We plunge into the jungle of technical indicators. This style of trading is a complex
activity built on foundations of layered simplicity. We deconstruct some of these complex
processes so you can rebuild them in a way that uniquely suits your trading style and
financial requirements.
This is database mining at its finest. We consider the value of Eyeball Searches
which provide an essential reference point for every trading decision. We place it near
the beginning of our search and also return to it towards the end. Some choose to use this
bar chart analysis only at the end of their search but the techniques do not change. Other
chartists look for Technical True Love - Searching for Relationsips
between price patterns and daily price bars. Other technical traders prefer Performance
Searches as the best way of quickly finding trading opportunities. All these
techniques use common concepts to bind complex groups together. Working with simplicity
provides the keys to complexity.
This understanding lets us build effective criteria for speedy searches that quickly find
the best trading candidates. Some search criteria are spelled out for you to copy into
your charting or market software package. Those who want to fiddle and fine tune further
will find specialist publications listed in the text.
The nuggets uncovered are still untested in the crucible of the market. We consider a new
indicator, the Multiple Moving Average, used as An Assay test - Looking for Life
in Chapter 10. This combines our understanding of market behaviour with data analysis to
identify points of explosive price action. Price data is objective, but our analysis of it
is not. There are always Two Sides to the Same Coin and we examine ways
to identify and ultimately overcome our personal predisposition for gloom or glee. With
this ghost acknowledged we finish the assay test interpretation and application with some Index
Hunting to match nuggets of trading opportunity with markets.
SUPPLEMENTARY NUMBERS
Discovery is nothing without exploitation. Our selected trading opportunities, mined from
our database, come in different shapes and sizes. Not all trades are created equal and in This
Nugget Goes to Market we examine the calculations required to rank the candidates
from good to better and then best. The best satisfy our financial objectives. We breathe
life into risk whenever we open a trade so Pinning a Number on Risk gives
us an important advantage in validating financial objectives.
The key to successful exploitation of our hard won trading opportunities comes in the
shape of Depth of market Information. This unfamiliar collection of
figures is too often ignored by traders, yet it opens a wealth of tactical information. We
show you some ways to understand and use it to your advantage. This puts profit in our
grasp and most times we stop here. Sometimes we are able to step beyond this analysis
crossing into the world of derivative trading. This gives us A Lever to Lift the
World so we explore the power of leverage delivered by specific warrant trading
tactics.
FAILURE IS A HANDMAIDEN TO SUCCESS
We cannot just go through the motions of trading. It is not a mechanical process. Trading
is hard demanding work. It requires a thorough working knowledge of the market, of trading
techniques and of money management. Above all it requires a psychological mastery of
ourselves. At some stage every prospecting expedition comes to resemble a pilgrimage.
Trading imposes stresses quite different from those experienced in any other job, and many
would-be traders find that it is these psychological factors that defeat them.
The way we think about ourselves has a significant impact on the way we trade. Trading
slides into Over-Trading when we abandon planning for movement, mistaking
activity for purpose. Successful traders recognise this escape mechanism, and put it in
the background so it does not distort their trading activities.
Behind every decision the trader makes there lurks a plethora of past sins and prejudices.
Failure waits on every trade and there are factors other than the analysis of the trade
that have a significant impact of our trading success. Stop loss is good in theory but
difficult in practice. Success depends on knowing the difference between Nerves of
Steel - Or Chicken Wire. We look at matching stop loss points with our nerves to
improve stop loss execution. Puffed with success from other financial activities some
traders mutate into a market bully, sabotaging their own success. The market ignores Command
and Control strategies so if you find yourself nodding in agreement, then heed
the warning.
These are hidden hands driving, or sabotaging, our decision making. Get to know them well
because they are our trading companions always hitch hiking a ride with success. These are
hidden attitudes which cast a pall of darkness over our trading activities, shadowing the
way to failure. We cannot eliminate, nor ignore them, so we must learn to live with them.
The most dangerous shadow of all is the unconscious belief that trading is a game of
chance where anyone can walk off the street and take money from the market. Gambler
or Trader? takes a professional look at trading behaviours suggestive of
pathological gambling. Written specially for this book by a US private trader and
psychologist, Paul I Munves, this chapter cuts authoritatively to the core of the gambling
trader's self deception. It is not pretty reading, but nor are the consequences of
gambling in the markets.
We are not alone in this expedition. Others search alongside us for nuggets. Some of them
are real competitors but most are temporary participants. We want to emulate the survivors
but few are initially aware of the Insight and Irony this involves. This
book is only an introduction to some of the tools used in trading tactics. It does not
complete the question "I am a trader because ..." That is your task and the
prospecting expedition turns out to be as much about this as it is about finding trading
opportunities.
Finally for those contemplating exploration in Foreign Jungles we provide
a brief guide to the important differences between the operation of Australian and US
markets.
AN INTRODUCTION NOT A GUIDE
The procedures detailed in the following chapters are only one selection from many ways to
approach the task of analysing the market for opportunities. Our purpose is to provide you
with an introduction to a variety of approaches to encourage you to think more clearly
about your current methods, or to help you make sense of the bewildering volume of market
data. We want to provide you with the tools to finance, equip, explore, develop and
exploit your own trading opportunities.
We approach trading as a business so we must be systematic in the way we go about the many
tasks associated with trading. This introduction will help you organise these tasks into a
daily routine to take you quickly to the best of the current trading opportunities whether
they be found in Lasseter's reef, King Solomon's gold mines, El Dorado or your own private
mother lode of market data.
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