The Wagner Weekly
February 3, 2003

Do you have a plan?

In last week's issue of The Wagner Weekly, we discussed the concept of assessing your trades based NOT on the profitability of the trade, but whether or not you did the right thing and stuck to your plan. While we received a lot of positive feedback on the article, it suddenly occurred to me there was one problem with advising traders to determine trade success based on whether or not they stuck to their plan. That problem was that most traders don't even have a trading plan!

In my years of working with and educating other traders, the most amazing thing I have consistently come across is how few of them have written, tangible trading plans. Any successful entrepreneur will tell you that he/she would never even dream of starting a business without a written business plan detailing every facet of how their business will be run. Yet, trading is the one business in which just about everyone who attempts to trade for a living does so without having a written business plan. It's no wonder why most traders eventually fail! Sure, most traders have a mental idea of what types of trades they take and how they manage their trades, yet very few ever take the time to put their plan in writing. In my opinion, any trading plan that is not in writing is absolutely useless because it is too easy to change your rules and not stick to the plan if it is not written.

One comment I frequently receive from subscribers of our ETF Real-Time Room is that they are amazed by my rock-solid trading discipline and want to know how I have achieved such discipline. Aside from the "school of hard knocks" (which charges a very high rate of tuition), the best way to achieve discipline is through having a written trading plan with clearly defined rules. If a trade is going against me and I am not sure if I should cut the loss or stay in the trade, I simply reference my written plan which has clearly defined rules based on a variety of parameters. Without a written trading plan, there is nothing on which to base my daily trading decisions in an objective manner.

While I could literally write an entire book on developing a trading plan, I will keep it simple in an attempt to motivate you to at least begin the basics of constructing your own personal trading plan. Rather than telling you all the things your plan should contain, I am providing you with the first page of my own personal trading plan that I currently use and live by on a daily basis. The first page of my trading plan is simply a general outline, but it contains plenty of material to get you started. Once you have your outline constructed, you can use it as a basis for diving into more detail with each of the concepts.

Here is the first page, the general outline, of my personal trading plan. The only thing I have changed is I have reduced the amount of trading capital from the actual amount I work with down to a fixed number of $100,000. This has been done in order to provide a realistic amount of capital (including margin) that many traders have access to:

My Trading Plan Outline
1 Objective
To consistently make 1 point of profit per day (net after commissions), through a combination of intraday and multi-day swing trading of exchange traded funds (ETFs).  
Based on the average share size determined below and account equity of $100,000, this translates to a net profit of approximately $300 per day on winning days, 
with the ability to let some days grow beyond that based on proper money management.  I want to be profitable on 80% of the trading days,
which correlates to an average of one losing day per trading week.  Losses on losing days will not be larger than my average profitable day.  Under no circumstances 
should losses ever exceed 2% of account equity in any given day.  Overall, each week should average a net profit of $900.
Here is a summary of my profit objectives:  80% x 5 trading days = 4 profitable days x $300 = $1,200 - $300 (one losing day) = $900 per week
2 Trade share size management
a Maximum trade share size
Average trade share size is based on the Morpheus Trading Group Position Sizing Model, which takes into account factors such as
price of the ETF, volatility (beta), strategy (swing or intraday), futures action, and account equity.
Multiplier ratios listed in MTG Position Sizing Model are adjusted based on account equity, with largest single trade being equal to no more than 25% of account equity
Based on this, my benchmark average position size for SPY is 300 shares, with all other ETF position sizes adjusted accordingly
Maximum trade share size must allow a risk for the trade, based on the stop loss, of no more than 0.5% of account equity. 
Here is an example of how to determine maximum position size: 
100k account x 0.5% max. loss = $500 max. loss per trade.  $500 / 0.50 stop = 1000 share max. for a trade (with 1/2 pt. stop)
b Plan to increase trade share size with successful trades
In general, share size is only increased with trades that are already in the money.  With rare exception do I average on a losing position.
Position size on a winning position is increased incrementally, with no single trade (or trade combination of the same sector) ever exceeding more than 25% of total buying power.
I will add no more than 50% of my original position size upon the trade becoming more than one point in the money.
An additional 50% of the original position size is added upon the trade becoming two or more points in the money.
3 Profit and loss limits  
a Maximum account draw downs
Stop trading for the day if net loss exceeds 2% of account size.  My top priority must always be to live to see the next day in the business.
Stop trading for one week if account draw down reaches 10%.  Take time to review trades and assess my current psychology.
Stop trading the account indefinitely if account draw down ever reaches 35% (kickout).  Something is definitely wrong if this happens!
b Maximum loss for a trade
Set trade share size and stop loss so that maximum loss for an intraday trade does not typically exceed 0.5% of account equity.
Set trade share size and stop loss so that maximum loss for a swing trade does not typically exceed 1% of account equity.
c Profit point at which I guarantee myself a breakeven day
When a realized plus unrealized intraday trading profit of 0.5% of total account equity is reached: Stop trading and exit trades if profit drops back to zero.
d Daily profit target, and what to do when it is reached
When a realized plus unrealized intraday trading profit of 1% of account equity is reached: Stop trading and exit trades if profit drops back to 0.5%.
When a realized plus unrealized intraday trading profit of 2% of account equity is reached: Stop trading and exit trades if profit drops back to 1%.
When a realized plus unrealized intraday trading profit of 4% of account equity is reached: Reduce position size by 75% on any new trades and use trailing stops on existing trades.
4 Trade Strategies
a Times of day that limit trading
9:30 Market opens
9:35 Initiate trades on fade candidates (only if large imbalance in futures)
9:50 Beginning of first reversal period
10:10 Trading session 1 begins
11:30 Trading session 1 ends.  Lunchtime doldrums begin.  Don't initiate any new trades.  Carefully watch exisiting positions.
13:00 Review plays from morning session.  Scan markets for afternoon plays and changes.
13:30 Lunchtime doldrums end.  Trading session 2 begins.
14:15 Trading session 2 ends.  Prepare for 14:30 reversal period.
14:30 Strong reversal periods often occur here.  Begin trading session 3.
15:30 Start to close on intraday trades and end session 3.  Adjust positions for overnight by looking for good entry points.
16:00 Market closes
b Types of allowable trades (setups)
General trading style is determined by whether or not market is trending or trading sideways for the day.  If market is trending, I will trade broad-based index ETFs
such as SPY, DIA, and QQQ.  However, if market is trading sideways, I select ETFs that are exhibiting strength or weakness relative to the S&P or Nasdaq Futures.  
This is done through sector trading the HOLDRS family of ETFs.  General concept is to be short the sector ETFs with the most relative weakness and long those with the most relative strength
This enables me to minimize risk and increase profitability through diversification and being hedged on both sides of the market.
Specific trade types are as follows:
Buy ETFs that have broken out of consolidation patterns at the highs on the daily chart. Upon breaking out and then pulling back down to breakout level several days later, I look for an entry.
These make great swing trades with minimal risk.  Stops will generally be slightly below the consolidation level.  50% of profit will be taken upon testing the 
former highs of the breakout, with a trailing stop on the second half of the position
Sell short ETFs that have broken down below consolidation patterns at the lows on the daily chart. Upon breaking down and then rallying back up to breakdown level several days later, I look for an entry.
These make great swing trades with minimal risk.  Stops will generally be slightly above the consolidation level.  50% of profit will be taken upon testing the 
former lows of the breakdown with a trailing stop on the second half of the position
Sell short ETFs that are in a downtrend on the daily chart upon rallying into the upper channel of the downtrend line.  However, it is important to wait for confirmation of the
reversal first.  This will generally take the form of some sort of reveral candle such as a doji star or inverted hammer.
Buy ETFs that are in an uptrend on the daily chart upon selling off down to the lower channel of the uptrend line.  However, it is important to wait for confirmation of the reversal first.
Typically I am looking for some sort of reversal candlestick such as a doji star or hammer.
Buy ETFs that have broken above the upper channel of the downtrend line on a daily chart.  Upon breaking the downtrend line, I wait for confirmation of the continuation of the breakout
by waiting for a retest of the upper channel of the downtrend.  The only time I will play the breakout is if there is some sort of confirmation candlestick with the breakout.
Sell short ETFs that have broken below the lower channel of the uptrend line on a daily chart.  Upon breaking support of the uptrend line, I wait for confirmation of the continuation of the breakdown
by waiting for a retest of the lower channel of the uptrend before entering a position.  The only time I will play the breakdown is if there is some sort of confirmation candlestick with the breakdown.
Moving averages play a key role in my trading plan, as they indicate the general direction of the market's trend.  I use 20, 40, and 200-period simple
moving averages on various timeframes including 5, 15, and 60 minute intraday charts.  Crossovers indicate potential trend reversals.
5 Record Keeping
a It is important to carefully track the performance of each of the above trade types.  As I notice that certain trade types are no longer working well, I will be dynamic in adjusting the style to the market
conditions because the markets are always very dynamic.  New types of trades will only be initiated with minimal share size and precise record-keeping.
b Upon the close of each trading day, I will complete my equity curve data in order to track performance.  Performance measured is performance gained (see Equity Curve spreadsheet)
c Each night, my technical research will produce a list of potential long and short plays for the next trading day.  This will be structured by sector and will yield target entry prices.
Trades are selected from the list of ETFs that MTG trades on a daily basis.
6 Ongoing Training
a Books
I realize the importance of reading at least one different trading book per month, as it keeps me focused with precision on the task at hand.  Books to continually re-read are:
Trading For A Living by Dr. Alexander Elder
Reminicenses of a Stock Operator by Edwin LeFevre
The Long-Term Day Trader by Michael Sincere and Deron Wagner (to keep me focused on the things I already know)
How I Made $2 Million In the Stock Market by Nicolas Darvas
7 Trading Rules

1     If I still like the trade, set alarms for re-entry prices upon cutting losses on a losing trade              

2     It's better to pay a worse price to get a lower risk entry             

3     Without an assistant, limit myself to four simultaneous positions               

4     Trade confidently and aggressively or don't take the trade.            

5     Want what the market wants.  (Don't fight the trend)             

6     Remember the best traders are out of the market more than they are in the market                 

7     Utilize the power of buying information with 100 share lots            

8     Wait until there is money laying in the corner and all you have to do is go over and pick it up. James Rogers (Have patience!)                 

9     Don't be concerned with commissions and fees (especially when using a per-share broker). It makes no sense to try to save $5 in commissions to lose $100 on a trade              

10    Be emotionless when trading. Never get excited when having a good day. Don't get discouraged during a bad day.            

11    Get at least six hours of sleep per evening.  I need to be alert!      

12    Leg into positions when shorting a stock with intraday relative strength and buying a stock with intraday relative weakness             

13    Relative strength: stock should have strength to the sector, which should have strength to the market.  The inverse is true with relative weakness

14    Reduce share size on each subsequent entry in the same position in the same day.              

15    Wait for entry prices to be triggered.  Do not overtrade.              

16    It's okay to have an opinion where the market will go each day, but don't cling to my opinion. The market is always right!            

17    Do not play breakouts during lunch.            

18    Always determine risk and stop loss before entering any trade.  Always utilize risk management spreadsheet.            

19    Never sell short into a gap down. Never buy a gap up. Either fade the gap or wait twenty minutes for market to settle before entering market. MTG Opening Gap Rules summarizes this. 

20    Remember that successful trading is a journey, not a destination. I will never know it all.                

21    Always plan at least two hours per evening to study the markets and research for the next day             

22    Remember facts are priceless and opinions are worthless.  Don't be persuaded by other traders' opinions            

23    Expect and accept losses gracefully.  Too much money is lost in missed opportunities by brooding over past losses.            

24    I cannot do anything about yesterday. When one door closes, another door opens. The greater opportunity nearly always lies through the open door 

25    Trade the leaders, not the laggards                

Use the outline above as a model from which to begin developing your own personal trading plan. Although it would be easy to simply copy my plan, it would not do you much good because every trader has a different risk tolerance and style that he/she is comfortable with. In other words, your trading plan needs to "fit" you like a custom-tailored suit. If you are serious about being successful as a trader, having a written trading plan is a mandatory initial step to success. Without it, your chances of consistent, long-term success are very slim. One of my favorite quotes sums it up well, "By failing to plan, you are planning to fail." Think about that and hopefully you will take the first step towards long-term success in trading. We will analyze trading plans in more detail in future weekly newsletters.


Weekly Reality Report

Without a doubt, January was a challenging month and was the first month since inception in July 2002 that Morpheus Trading Group did not achieve net profitable results (although Morpheus was nearly breakeven). For the month of January, we netted 3.89 profitable points from The Wagner Daily trades and lost 3.93 points from trades called in the ETF Real-Time Room. Based on the sample MTG Position Sizing Model, which includes trading commissions, we lost a total of $98 for the month. Close to breakeven, but no cigar.

Unfortunately, our loss for the month of January can be attributed directly to an aggressive, calculated risk we took on a multi-week trade. We bought a double position size of BBH (Biotechnology HOLDRS) when it broke out of a multi-month ascending triangle pattern on January 16. Although we rarely take more than one full position size of any trade, we liked the setup and risk/reward ratio so well that we took an aggressive stance and bought twice our normal position size. At the time, we were risking about 4 points to make 12 points (based on our price target). The trade would have obviously been highly profitable if it worked out, but strong selling in the broad market eventually caused BBH to drop to our stop price, despite its relative strength on the daily charts. Upon doing some analysis in hindsight, I still would have made that same trade again, but perhaps would have used scaled stop prices to minimize risk. This means I would have used multiple stop prices to leg out of the trade if it went against us. That's trading!

Below is a summary of the performance of each MTG trade that was closed during the week of January 27 - 31, 2003. The larger-than-usual drawdown from the ETF Real-Time Room last week was due to closing BBH at a significant loss. Any open positions are not reported until the week they are closed.

Trades from The Wagner Daily:

Trades from the ETF Real-Time Room:

Click here for a detailed explanation of how Morpheus Trading Group calculates and reports its trading results.

Click here to view a detailed cumulative summary of every MTG trade since the end of October, 2002 (updated weekly).

Odds and Ends

 I'm excited to announce the national publication of some new educational trading articles I recently wrote for two magazines. The first article, entitled "Short-term Sector Trading With ETFs," can be found on page 52 of the March issue of Active Trader magazine. The second article, entitled "Navigating Choppy Sideways Markets," begins on page 11 of the February issue of SFO (Stock Futures and Options) magazine. Both issues are now on sale at your favorite newsstand.

Time is running out to sign up for my ETF workshop at the International Online Trading Expo. in New York City on February 27, 2003. Click here for more details.

Remember that free trials to all MTG services are available by clicking here (limit one per household).

As always, thanks for spreading the word about Morpheus Trading Group and all the benefits of ETF trading!

Deron M. Wagner
Founder and Editor

Morpheus Trading Group
www.morpheustrading.com
The Leader in ETF Trading!

DISCLAIMER: There is a risk for substantial losses trading securities and commodities. This material is for information purposes only and should not be construed as an offer or solicitation of an offer to buy or sell any securities. Morpheus Trading, LLC (hereinafter "The Company") is not a licensed broker, broker-dealer, market maker, investment banker, investment advisor, analyst or underwriter. This discussion contains forward-looking statements that involve risks and uncertainties. A stock's actual results could differ materially from descriptions given. The companies discussed in this report have not approved any statements made by The Company. Please consult a broker or financial planner before purchasing or selling any securities discussed in The Wagner Weekly ( hereinafter "The Newsletter"). The Company has not been compensated by any of the companies listed herein, or by their affiliates, agents, officers or employees for the preparation and distribution of any materials in The Newsletter. The Company and/or its affiliates, officers, directors and employees may buy, sell or have a position in the securities discussed in The Newsletter and may profit in the event the shares of the companies discussed in The Newsletter rise or fall in value. Past performance never guarantees future results.
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