Chapter 9. Pick Your Time Frame
In the world of mathematics, the word fractal describes a shape that can be subdivided into parts, each a smaller copy of the whole. One of the greatest qualities about the pattern-recognition strategy is that it is fractal, in that you can use it across a multitude of time frames. For instance, the reasons how or why lateral or angular trends apply to stock movement are true over the course of several hours, as well as over several days, weeks, months, and even years. Because of this fractal nature, pattern recognition is a strategy suitable for a variety of traders regardless of their available time during the trading day to actually trade stocks. Because inflection points gain significance through human emotion, this emotion is present and can be seen just as easily on a ten-minute chart as it can on a weekly chart. Of course, the size of the move and time it takes to play out will usually correlate with the time frame you are reviewing. For example, look at the American Express (AXP) chart that Figure 9.1 shows and verbally state what you see based on what you learned in the preceding chapter.
I suspect you said something about the ascending trend and maybe went into a bit more detail about how you would trade the potential break down or reversal at support. Would you be surprised if I told you this was a ten-minute chart over a series of three days? What this means is that each bar represents a ten-minute time frame rather than one day, as is commonly the case.
How about the Gilead Sciences (GILD) chart that Figure 9.2 shows? Take a look at this and again relay your thoughts as if I were sitting in a chair next to you right now.
Would you be surprised to learn that this chart is actually a weekly chart covering the past three years?
Figure 9.1 American Express after breaking an angular ascending trend.
Chart courtesy of Worden–www.Worden.com.
Figure 9.2 Gilead Sciences breaking an angular ascending trend.
Chart courtesy of Worden—www.Worden.com.
One reason I never accept the excuse that someone does not have the time to become a successful trader is because of the fractal nature of pattern recognition. Sure, you might not have the time to trade ten-minute patterns, or maybe not even the time to trade daily patterns. However, if you want to be successful trading stocks and cannot review weekly charts sometime during the course of a month, you should probably avoid trading altogether. The good news is that with this strategy, a few hours per month can yield incredible results.
While the fractal nature of pattern recognition lends flexibility to traders with different schedules, it also opens the door for a common mistake among traders. Many traders never honestly assess their own schedules to gain a true understanding of how much time they can devote to trading. Without this finite understanding, it becomes a challenge to hone in on a time frame that suits you and the time you have to trade. What I will call time frame jumping can lead to frustration as you struggle to fit your personal schedule into the time frame you desire to trade, instead of adopting the appropriate time frame that fits your personal schedule.
Trading is all about knowing yourself. To be a truly successful trader, you need to look deep within, making a conscious decision to wrestle with those ugly qualities you don’t want anyone to know about. If you do not do this, the market will seek out these qualities, prey on them, and use them to separate you from your capital. Maybe you struggle with emotions and tend to get caught up in the excitement when stocks are moving quickly. Out the window goes your discipline, and soon you are chasing names, filling up your position sheet with a long list of stocks that you aren’t even sure why you bought in the first place just a few hours later. Or perhaps you wrestle with pride. Despite losing money time and time again, you still believe you know what the market should do. Rather than humbly approaching the market movement, willing to flow with whatever happens, you attempt to impose your beliefs on the market and force your strategy on the action. Although this might work for a season, it won’t work for long, and you will quickly lose. Maybe you haven’t truly reflected on your personality and how that correlates with your trading, or perhaps you are trading one time frame when in fact your schedule mandates you trade in another. A trading mentor and dear friend always encourages me with these words: “Be comfortable in your own skin.” These words ring in my ears loudly, and I admonish you to take them to heart. Pause a moment and reflect on this a bit and how it applies to your own trading.
Before placing a single trade, you must firmly understand your schedule and how it influences the way you trade stocks. So often when I work with traders one on one, reviewing their previous trading records, I see a big disconnect between the trading world they desire to live in and the reality in which they actually live. When questioned about specific trades, they may discuss the pattern they saw that had evolved over the past day or two, or how a specific move in the market or other sectors sparked them to action. As they continue to tell me their stories, I see and hear strategies that would be suited for traders who can sit in front of the computer all day, capitalizing on the short-term fluctuations or swings in price or sector action. Even though the strategies are often sound, they don’t quite fit with the life of business owners who in reality can sit at their computer only once or twice a day, checking the market for an hour or two at the most.
I’ll never forget one of my boot campers, John, a dentist from Michigan, who struggled with this precise issue. John had an advantage over most investors in that his pattern-recognition skills were impeccable. He had become a student of chart reading and had approached the tape with the same precision as his successful dental practice and his scratch golf game. Despite these skills, however, he could not make consistent profits and was becoming discouraged by the endless downward spiral that seemed to plague his trading. As our dialogue increased before his visit, I assumed the issue would relate to his risk management or capital deployment. I thought that possibly John, like many in 2009, was getting too hung up on his opinions or a bias and was scared to deploy capital on the long side. Like approaching the market, I should have known better than to assume I understood what the issue was before spending significant time with him. I was pretty confident that even before he ever stepped foot on Kentucky soil, I had all the answers he needed. As we settled in during that first evening and discussed the past year, I quickly learned just how incorrect my assumptions were.
John talked to me about his daily routine. He told me that despite a full-time dentist practice he still put in many hours per day of chart work and market study. He followed along in my chat room and studied the stocks discussed there. His daily regimen produced a plethora of opportunities. However, when it was all said and done, his P&L did not reflect his skill level or work ethic at all. Despite his clear understanding of pattern recognition, John assumed he was missing something in his reading of the tape. John assumed that for him to become more consistently profitable he had to find better opportunities. Regardless of the fact that his initial assumption, like mine, was wrong, he possessed the humility to accept the fact that something had to change. He wasn’t making money, and that was the only indicator he needed to know about.
As we spent hours discussing his trading, it became incredibly clear to me that the issue John was facing had nothing to do with mechanics. He could read the tape very well and knew how to check his emotions at the door. However, one glaring issue kept coming to light. With regard to moving in or out of a position, John often mentioned the short-term sentiment of the market or the short-term movement in his stock or another that led to his decision. When asked about a specific trade, he often said something like “I saw the ten-minute chart bottoming.” Or “I played the real estate names because that day I saw financials turning green.” It became clear to me that John was attempting to blend a very short-term strategy, or at least observe all the variables that would go into a short-term strategy, while in reality only being able to devote part of his day in front of the computer. You see, despite John’s desire to sit and trade all day, his ongoing dental practice obligations kept him away from the screens for several hours. When he would return to the screen, he would catch just a glimpse of what was happening during that moment and would often make his decisions based on that information. Because the market often moves in a chaotic fashion in the short term, it was impossible for John to gain any sort of rhythm or sustain any momentum in his account if he was trying to trade on one time frame because he didn’t really have the schedule to do so.
After recognizing this, it became clear to me that John did indeed have the potential to dramatically improve his returns but first needed to solidify his strategy much more. John had all the time in the world to study charts and find appropriate patterns. His schedule before and after market hours allowed him this luxury. However, when the market opened, he was distracted with other obligations. When he sat at his computer, he would make snap decisions based on short-term information that could change (often even between his patients). I strongly encouraged John to take a big step back and recognize that despite the allure, at this point in his life he did not have the schedule that allowed for short term trading. To be successful, he would have to focus his energy on a much more methodical approach, recognizing the opportunities presented in various patterns, taking them, and letting them play out. Furthermore, I encouraged him to avoid any “noise” that contradicted this strategy, shutting down the chat room and turning off the television if necessary.
To help John make this transition, we implemented some guidelines. John had lost a tremendous amount of confidence over the years, and it was important to rebuild this as quickly as possible. To do so, we had to reduce his portfolio risk, which meant that first we significantly reduced the capital John was trading so that he could become comfortable with his new strategy without being concerned about his entire account. Once he gained confidence for the time frame of his focus and had some “wins” under his belt, we increased the money he traded in a methodical fashion. We then limited the number of trades John could have at any one time to four. This kept John focused on selecting only the best four stocks. If another arrived that he thought had more merit, he would simply have to wait until either taking profits or it could replace one of his original four. Finally, we set a specific time frame that John would look at when selecting his trades. We banished the 5-, 10-, and 30-minute chart, and John could not delve into this short-term world. He needed to focus on the daily charts and thus give his trades much more time to play out (and not be shaken or distracted by the intraday movement). We concluded his rules by simply stating that once a position was taken, with a precise plan laid out from the onset, he would stick with that plan no matter what.
As is my custom, I follow up with all my students on a regular basis. John came to visit me in October 2009 and spent much of the end of 2009 reflecting on his experience with me and his new strategy. As of the first week in 2010, John had returned more than 3%, taking very limited risk, and was feeling more confident than ever. By the end of June, John was up over 10%, while the general market as measured by the S&P 500 was down close to 8%. An 18% outperformance halfway through the year is fantastic. John understands that there will be progress and there will be setbacks. However, I believe that John now has the requisite foundation in place, is comfortable in his own skin, and is making progress toward consistent success. John and I have since become great friends, and during a recent visit I smiled ear to ear as I heard his lovely wife talk about just how much their lifestyle had improved as a direct correlation to the reduction in frustration he experiences trading. Bravo John!
You might be under the impression that your trading time frame will somehow correlate with your returns. The excitement and faster pace of shorter-term price movement often insinuates greater opportunity for gain. I can understand how you may view those trading in this world and surmise that their returns should be exorbitant. It has been my personal experience, however, that this couldn’t be further from the truth. Just as more opportunities for success are presented through shorter-term charts, so are the opportunities for failure, which can quickly alter your emotional capital if you experience a few losses in a matter of hours rather than days.
I remember vividly when it first all clicked for me. It was as if I were an artist finally finding my canvas. I understood pattern recognition and how to capitalize on the opportunities that were presenting themselves day in and day out. I had developed a way to calculate my risk ahead of my trade and had developed a profit-taking strategy that never let gains turn into losses. I saw firsthand how exercising my statistical edge over a sample set of trades produced a consistently rising equity curve. My excitement grew as I viewed my trading like I was the casino, with a small house edge, capitalizing on the never-ending supply of players that sit starry eyed at the blackjack table attempting to secure their future fortune. The house knows it may win some hands, it may lose some hands, but over the long haul its proven edge will bring in enough money to build lavish buildings and famous fountains. The system all made sense to me, and before long I concluded that to dramatically improve my returns and reach my maximum potential, like a vast casino floor, I had to be in as many trades as possible. Although the outcome I desired might have been possible statistically and is the foundation for many black-box computer strategies, I did not consider the human factor or my personal emotional makeup.
The day began, and it didn’t take long for me to find my first few trades based off 30-minute chart patterns I had been studying over the past few days. I did not hesitate entering the trades, setting my stops as well as my profit-limit orders. Within the first 20 minutes, I had come across two oil and gas names that looked to be rolling over on the 5-minute charts. Again, I entered the trades and kept right on moving along. By 10:30, my daily alerts started to trigger, notifying me of longer-term trades I had been stalking for some time. I did not hesitate to enter those trades, too, adding even more inventory to the position sheet but remaining well in control of all that was going on. As I entered those specific trades based on the daily charts, my early trades on the 30-minute charts were stopped out for losses (while my 5-minute chart patterns played out and reached their first few profit levels quite quickly). While I was assessing the initial stop damage, taking some gains in the 5-minute chart patterns, I again had a few more alerts go off for charts based on ten-minute patterns. I scrambled to review those charts, while at the same time trying to manage my existing trades and review other daily alerts that started to trigger. While I booked early gains on the 5-minute chart patterns, the subsequent share amounts were stopped out and I was caught off guard when they reversed hard and created a little more slippage than I would have liked in the account. As the day wore on, I became more and more entrenched in the management of my own little casino floor. A few initial losses did more psychological damage than I expected, which had me hesitating on subsequent trades as they set up. When I began hesitating, I began missing opportunities.
It was the longest trading day of my life! When it was over, I had traded more that day than I had on any particular day in many years. The net return, while positive, wasn’t nearly enough to justify the tremendous amount of work I had put in during the day. Furthermore, as I wrapped up the day, I stumbled on a few daily patterns I had missed throughout the day as my attention was focused elsewhere. This was rather discouraging because these patterns had evolved into what would have been outsized gains far greater than what I had made the whole entire day. In addition to all the frustration surrounding the actual execution and trade management of that day, I realized that my enjoyment level was far below normal. I couldn’t put my finger on it. Some time later, I told a friend that the day was my first when trading felt like actual work. I subscribe to the idea “blessed is the man who cannot tell the difference between his work and his passion.” That particular day was no fun at all.
My statistical edge is proven, and I still do believe that growing the sample set for my trading style would reap great returns. However, it is not something I desire to pursue. Rather than increase the size of the casino floor, I just want to hone in on the time frame and patterns that I find most comfortable. I want to strive for perfection within this world, and rather than increase the number of trades I enter, I want to increase the risk I take per trade. I accomplish the same end result without the manic activity.
The fact that pattern recognition may be applied across a number of time frames is both a blessing and a curse. You must first honestly assess the time you have to dedicate to trading, and thereby focus solely on the time frame that correlates with your personal strategy. When you have a firm grasp on pattern recognition as a strategy, and a core time frame from which to trade, you are ready to learn about actual trade management and the science behind consistent profitability.