Wheelie’s New Improved Index Trading System - Part 2 of 3

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This is the Second Part in what should be 3 chunks regarding what is a pretty complicated and hefty subject - before getting stuck into this, I would strongly suggest reading Part 1 which you can find here:

http://wheeliedealer.weebly.com/blog/wheelies-new-improved-index-trading-system-part-1-of-3

Trade Types I am particularly looking for
As with all things in Trading and Investing it is extremely important to strive for simplicity and in line with this I essentially have 4 different ‘Types’ of Trade Setups that I am particularly after; and they can be grouped into 2 different types - Long and Short.

In the Final Part of this Blog Series I intend to produce some Examples using real Charts of these types of Trades so Readers can get a much better appreciation of what I am going on about.

Note: When placing any Trade it is always better to try to Trade with the Larger Trend, even if you are just doing the Trade for a few Days - this increases your chances of being right hugely. For example, when looking to go Long (in other words to ‘Buy’ an Index), try to find an Index where the Larger or Major Trend is up - i.e. there is a Major Uptrend Channel and you have just had a Short Term Pullback or Retracement within that Channel and now you are looking for the Turn and waiting to go Long. Equally, if you are looking to go Short, then try to find an Index where the Major or Longer Term Trend is down and you have just had a bit of a move up before the Trend is likely to continue dropping down again - always try to Trade where the Flow is in your favour.

Long Trades:

• Horizontal Breakout - this is where the Index has been bumping up against a Horizontal Resistance Level a few times and then it ‘Breaks out’ and smashes through the Resistance and charges higher. The best way to Trade these is to go Long as soon as we have the Breakout (I do this on an ‘End of Day’ (EOD) Close basis and I like to see a Bullish Candle of some sort) and sometimes the Price will just keep going up and in other cases the Price may ease back and ‘Confirm’ the Breakout Level with what was previous Resistance now becoming Support. If you wait for the Confirmation then you will miss a lot of Breakouts which just keep screaming higher (and you really want to capture these !!) so the best approach is probably to go Long on the Breakout and then if it pulls back to a Confirmation, use that as an opportunity to add more to your Long Position. A Stoploss would be best placed just below the Horizontal Resistance/Support Level - nice and tight so you don‘t lose much if the Trade doesn‘t work out.

 

• Bounce off the Bottom - When we have a general Uptrend in the Indexes (and in reality this is most of the time - for instance, we have had a Major Bull Market for 10 years pretty much now), from time to time we get some pretty chunky Pullbacks and also some smaller ones - these are often as much as a 10% Drop or perhaps only 5% - but they create superb Opportunities to go Long on an Index as they come up off the Bottom. I’m sure at this point loads of Readers will be saying “oh, but it is impossible to time the Markets and you cannot pick the Bottoms or spot the Tops”, but in fact if you use simple Technical Analysis techniques then you can get very near to both Bottoms and Tops. If you make a habit of reading my Weekend Charts Blogs then you will see that I have been using the same kinds of simple Technical Indicators like Candlesticks, RSI readings, Bollinger Bands, Trendlines etc. over and over to find both Bottoms and Tops. I suggest you get in the habit of reading my Weekend Charts Blogs and if you follow me on Twitter then most Evenings after about 10.30pm or so I am tweeting out about the Indexes and updating various bits of information around the Technicals on the Indexes. In practice there are some extremely simple ways of finding the Bottom such as looking for Hammer Candles, 2-day Harami Patterns, very low RSI Readings (30 and below), Price moving off the Bottom Bollinger Band, Narrowing Heiken Ashi Candlesticks etc. etc. The trick is to wait for the Bottom to be in and for the Index to have made the Turn - trying to anticipate the Turn is a big error and you are in effect ‘Catching a Falling Knife’ and you just don’t need to do it - be patient, and await the Turn. That way you are buying in just as the Index is likely to rise again and this lowers your Risk a lot. A Stoploss should be placed just below the Intraday Low Points of the Daily Candlestick where the Index turned - for example, if it is a Hammer Candle, then you would put your Stoploss just below the ‘Handle’ bit of the Hammer. These ‘Reversal’ Trades are by far the most common compared to the ‘Breakout’ Trades, and that applies to the Short Trades as well.

Short Trades:
These are really the opposite of what I talked about in the ‘Long Trades’ section above:

• Failure of Horizontal Support - a ‘Break-down’ - this is where an Index has been falling and it has touched a Horizontal Support Level several times and then finally it ‘Breaks-down’ and smashes through the Support (I think the Technical Analysis terminology for this is a ‘Ledge‘). Quite often it will keep dropping fast and it is best to go Short straight away (by this I mean after the Market has Closed I would look at the Break-down and I would like to see a Big Red Down Candle as it smashed through - that would be a good Signal to Short). Sometimes it might recover a bit and ‘Confirm’ that Previous Support has now become Resistance and if this happens then like with the Long example above, this could be an Opportunity to increase the size of your Short Position. A Stoploss would be best placed just above the Horizontal Support/Resistance Level - nice and tight.

 

• Turning down off the Top - these can be cracking Trades because in essence this is what I am most interested in for the purposes of ‘Hedging’ my Long Portfolio of Stocks. As with all ‘Turning Points’ you don’t want to anticipate it and go early - it is better to wait for the Turn and then get your Short Trade on. If you put the Trade on too early you will probably get Stopped out and if you wait for a ‘clean’ turn, then there will nearly always be a nice Inverted Hammer Candlestick or similar and you can put your Stoploss just above the Intraday high Point of the Candlestick - so it means you can spot the Turn nicely and you can have a very Tight Stoploss as well. Sweet.

With all these kinds of Trades it is worth trying to use a ‘Scaling-in’ Approach whereby you perhaps put on Half your Trade Size at the start and if it goes your way, then you add the other Half of your Trade Size. This means that if the Trade goes against you and your Stoploss gets triggered or you Close the Position early, then you only take a small hit. When you put the extra Half of the Trade on, it is often worth moving the Stoploss up (or down !!) behind it if that is practical (I talk more about ‘Trailing‘ Stoplosses in a later section to this Blog).

There are other Trading Opportunities which might sometimes be taken advantage of but in general these Trades I have outlined are the best ones to focus on. Get good at these before trying more advanced methods is probably the best way to do things. For example, one of my favourite kinds of Signals are ‘Golden Crosses’ and ‘Death Crosses’ from the 13 and 21 Day Exponential Moving Averages (EMAs) - such Crosses could be excellent opportunities to add to a Long or Short Position or perhaps to initiate one.

‘Turning down off the Top’ and ‘Bounce off the Bottom’ are both types of Reversals where a Trend in a particular direction changes to the opposite direction. One of my favourite Scenarios is to be Short on an Index as it drops on a Pullback and then to Close the Short near the Bottom and then to open a Long Position to try to catch some of the bounce back. The term in the Trade is ‘Stop and Reverse’……

Thoughts on how to Start out with such an Index Trading System
As always my Blogs and stuff on the Website etc. are not to be taken as Financial Advice and when I talk about subjects like my ‘Index Trading System’ it is as much for clarifying my thinking as giving Readers something thought provoking which may help them with their own methods of interacting with the Markets. I am in no way recommending that anyone should follow how I do things because using Tools like Spreadbets and other Leveraged Products can be extremely dangerous and lead inexperienced People to lose huge amounts of Money.

With that in mind, I was thinking about how it is best to start out on using a System like I am endeavouring to become highly proficient at. Without doubt before jumping in and doing Index Trading it is vital to make sure you really understand what you are about to try doing. This Blog Series should contain enough information to give you a good start especially once I have completed the Series with some Example Trades (these should be coming in Part 3 - patience !!). I would suggest you read this several times and make sure you really understand the concepts I am talking about. Following on from that, you can see the Trades that I open and close myself on my ‘Trades’ page and the Blogs about Charts that I produce pretty much every Weekend should help give you more skills and understanding as well.

The next step is to find some sort of Charting Package or Website which gives you Daily Candlesticks etc. and which saves your Information. I use ShareScope which is utterly brilliant but it is quite an outlay at around £260 a year but I find it money well spent. I think some Spreadbetting Platforms might have a decent Charting capability and I am pretty sure igIndex have something in this vein. In terms of Websites, I think the ADVFN.com Charting is quite good for our needs and Stockcharts.com seems very good and free to use. If you look at my Weekend Charts blogs, then these should give you ideas on what Indicators and Signals to setup on your Charts - but remember to keep it simple because complexity just makes your job much harder and you are less likely to succeed.

Once you are sure you have a good appreciation of what is involved, I am pretty sure that igIndex do a ‘Practice Account’ which should work very much like a real ‘Live’ Spreadbet Account but of course you don’t have any actual Money in it so it is a way that you can try out a few things but with no risk of hurting yourself financially. The problem with such Accounts is that they lack the ‘Reality’ aspects and my experience of them has been that I very quickly got bored and found that I had to start using small amounts of actual Money to get more value out of the exercise. I guess it is ‘Horses for Courses’ and some people might find that such a Demo Account is actually extremely helpful and it is without doubt the best way to start out - even if you only use it for a very short time and just do a few Trades - at least it will give you an appreciation of how a Spreadbet Account works.

Of course the big problem with a Demo Account is that without real Money the Psychological and Discipline aspects are totally missing or at least very different - and for this reason there is not much point in spending too long using such an Account in my view. The next step is to open a proper Spreadbet Account and to put a small amount of Money in it and to then Trade using this - but the key is to keep the Bets very small. I have not looked into this in detail but I think igIndex have a minimum size Spreadbet on Indexes of about £2 a Point (that is certainly the case on the FTSE100 but it might differ on other Major Indexes), and this means that on the FTSE100 you would have an Exposure (this is in effect the equivalent amount you would have in the Market if you were buying Shares instead of doing a Spreadbet) of about £14,000 (this assumes the FTSE100 is at 7000). On this basis, it is very easy for the FTSE100 to move 6% or so in a few Days so you could end up losing £840 pretty fast (this is 6% of £14,000) or of course if the Trade goes in your favour, then you might gain £840 in this kind of example. I have not checked this recently, but I remember there was a neat Trick you can use on igIndex when they have a Minimum Bet Size like this - open the £2 a Point Trade and then almost straightaway just Close £1 a Point of it - so this way your Exposure is halved instantly….

Remember, these are Leveraged Trades so for an Exposure of £14,000 you might have to only put down perhaps £120 Deposit or something - so this can be extremely misleading if you do not understand fully what you are involved with. I have written lots of stuff about Spreadbetting in the past and I will include a link at the bottom of this Blog to a Blog Series I wrote specifically about using Spreadbets. I strongly recommend that before you do anything with Spreadbets you should read my Blog Series in full.

However, the key point here is that once you start using a Real ‘Live’ Spreadbet Account with actual Money, you need to fully understand what kind of Exposure you have and how the Numbers will move with regards to your Margin/Deposit and your ‘Spare Cash’ or ‘Free Cash’ or however your Spreadbet Provider refers to it (I often refer to this as my ‘Cash Buffer‘). So it is vital to be clear on your Position Sizes and of course where you Enter Trades and have your Stoploss needs careful thought and planning.

I would suggest that before moving on to larger Spreadbet Positions (with a higher £s per Point) you keep your Discipline very strict and limit your Sizes for maybe at least a Year - you need to prove over time that you know what you are doing and that you can avoid the Dangers and can consistently make Money. If you cannot achieve this, then it is extremely dangerous to move up in terms of Position Sizes and risk. On the flipside, if you can prove over a long period of time that you can make Money this way then it makes sense to raise your Bet Size and Exposure because it is supremely scalable and if it works for you at £2 a Point it will work at £10 a Point and £50 a Point and £200 a Point etc. - just stay in control and remember that this is a mathematical construct and that in ‘The Real World’ there are psychological aspects that come in to play to a large extent as you scale up - be careful !! If you must scale up, then do it in careful Steps, not in one sudden jump.

It is also critical that you keep a detailed record of all of your Trades and you might like to make notes about them as you perform them as this could help you with analysing your Performance and provide a useful way to review where Trades are not working out right and how you can take corrective action (this might even be worthwhile when using the Demo Account - try to make the simulations you run as real as possible). At the end of this Blog I have included a Link to a Blog I wrote which contains a Spreadsheet which you can use as a Template to enter your Trades on. Bear in mind that the ‘System’ is designed so that you will have losing Trades (they are inevitable and unavoidable) but when things go wrong you take a small hit but when the Trades go your way you win big. 

You will have periods when none of your Trades seem to go right and it is important when this happens to keep calm and to analyse how you are doing things and look for ways you can improve the Performance - it is usually because you are lacking Discipline in some particular aspect and you need to focus on this. Many Traders say that when you get such bad runs, it is often a good idea to ‘take time out’ and perhaps not Trade for a couple of weeks and just to review your Process and to figure out where your weaknesses are. If you are using real Money in a small way then perhaps you could even go back to the more theoretical ‘Practice Account’ and work with that until you are consistently getting your Results to improve.

Trailing Stoplosses
When I sketched out the original plan for how these Blogs would go, I totally omitted this bit so big thanks to Damo (@donutsareace on Twitter) for asking me about it in the Comments section under Part 1 of this Blog Series - it is an important part and certainly needs to be included.

As I have discussed elsewhere, when I plan a Trade before I execute it, a key part is working out where my Stoploss will be placed (although remember I do not use a ‘hard-coded’ Stoploss with my Broker - I will write more on that in a bit) and this is usually quite close to where I Open the Trade and I usually place it just underneath where I think there is pretty Strong Support. If the Trade then starts to go my way, I will most likely add to the Position and when I do this I might raise the Stoploss for both Trades or I might put the new Trade on with its own Stoploss - I am quite flexible on this point.

If the Trade then continues to move in my desired Direction (remember, this can be Long or Short), then I will look at moving the Stoploss up behind the Trade - this is what a ‘Trailing Stoploss’ is.

If I have not had the Trade in place for long, then I am probably expecting a nice gain to come and when this is the case, I tend to like keeping the Stoploss relatively generous as I don‘t want to get Stopped-out prematurely, so the first time I move the Stoploss might be to get it near to where I Entered the Trade or Trades and that would mean I cannot lose on that particular Trade, even if it then turns against me. Again, I will be looking for where there is pretty Strong Support and the main way I determine this is to use the Daily Candlesticks and their Patterns to figure out where this happens. For example, if I am Long on an Index, then I will be looking at the Low Points of Daily Candles and seeing where they go down to (i.e. where Support kicks in and the Buyers appear) and my Stoploss would be placed just below such a Low Point.

If I have had the Trade running for quite some time and I think we are nearing a Turning Point which would then mean that the Trade is likely to start going against me, then I might move up my Trailing Stoploss but have it much tighter to where the Actual Price is - this means that if it does turn, then I am out quickly and I have locked in a lot of Profit.

I think the Book ‘Candlesticks for Dummies’, which you can get a copy of from Wheelie’s Bookshop, could be very helpful on this aspect of the Trades. When looking at the various Candlesticks and their Patterns, the Book splits them into 2 different types - ‘Reversal Patterns’ which mark when a Trend changes direction and then ‘Continuation Patterns’ which tend to suggest that a particular Trend will keep going. If you understand these different Patterns, it should help a lot with regard to where to move Trailing Stoplosses to.

There are also other Support/Resistance levels like those provided by the most widely used Moving Averages like the 20 Day MA, the 50 Day MA and the 200 Day MA and even the Bollinger Bands - I find these are less useful but sometimes they can help.

WARNING !!
There is a significant flaw with how I am doing my Index Trades at the moment and I am pondering how best to address it as it is certainly not an ideal situation. The problem arises because in extremely rare circumstances, it is possible for the Markets to Spike Downwards in an extreme way during the Day and if you have a Long Position running, then you could quickly wipe out your Cash Buffer in your Spreadbet Account and the Spreadbet Company would probably Close your Position for you and this could mean a huge Loss. And needless to say pretty soon after this the Market turns up again and you have in effect been ‘Stopped out’ with a big Loss for nothing.

This problem does not arise if you have Short Positions in place - in fact, if you see it happening during the Day then you might be really lucky and be able to nip into your Trading Account ever so fast and get the Position Closed at an extremely big Profit before it quickly shoots back to normal - you would need to be really lucky to manage this though.

At the moment I put on fairly large Long Spreadbet Positions and if there was a Spike down, it could cause me a lot of grief. This is partly because I do my Stoplosses on an ‘End of Day’ Close basis with a Manual Trigger but perhaps I really should start placing firm Stoploss Orders with my Broker. However, a ‘Normal’ Stoploss Order might not be enough (the Market could move too fast and you get Stopped Out much lower than you wanted to so you still have a chunky Loss) and perhaps the only way to be truly safe is to use a ‘Guaranteed’ Stoploss Order - although this has an extra Cost.

Another way around this problem might be for me to stick to my EOD Close Stoplosses with Manual Trigger but to place a Normal Stoploss Order with my Broker perhaps 10% below or something - like a sort of ‘Safety Net’. I will ponder more on this. It is an extremely rare event and with the advent of ‘Circuit Breakers’ since the Credit Crunch Meltdowns (this is where if a Stock or Index moves too fast then the Stock Exchange halts trading for about 5 minutes or something so that Market Participants calm down and use their Heads before Trading starts again), they are perhaps even more unlikely. However, one event that does stand out for me is when the Twin Towers got smashed back in 2001 - from memory, I think the Indexes dropped about 6% really fast and that would have created a big Loss for me if I had a Long Index Trade in place, but of course it also depends on the size of Bet you have and the Spare Cash Buffer in your Account. One possible way of mitigating the Problem would be to keep Long Trades at a smaller Size than Short Trades - that again is something I will mull over.

Just to recap, part of the reason I don’t like ‘Hard-coded’ Stoploss Orders with my Spreadbet Provider is because of Intraday Spikes which can take out your Position just before it turns quickly back in your direction. However, there is another problem related to this when using Spreadbets in that they trade through the Night when you are asleep most likely, and this means that you could get ‘Stopped Out’ overnight only to find that this is a ‘false’ Market and bears little relation if anything to the Real Market during the Day and that, needless to say, then goes in your favour but you have been Stopped Out at a Loss and now you have no Exposure as the Market goes your way. This is a particular problem if the Trade has gone against you at the start but is still inside your Stoploss Level on an EOD basis but then Stops you out Overnight.

OK, that’s it for Part 2 - we have covered a lot of ground I reckon. In theory the final Blog of the Series should be shorter and simpler as it will contain some Examples with Chart Pictures and stuff and a short Conclusion - I have not started writing it yet so I am not totally sure what shape it will take - hopefully I can make it clear and easy to understand but I am making no promises !!

Cheers, WD.


Related Blogs:
Here is the Blog which has the Trade Recording Spreadsheets in it:

http://wheeliedealer.weebly.com/blog/spreadsheets-for-recording-your-trades

Here is a Link to the Spreadbetting Series - there are Links at the bottom of this one to the earlier Parts:

http://wheeliedealer.weebly.com/blog/how-to-use-leverage-safely-and-successfully-spreadbetting-and-cfds-part-7-of-7