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Daryl Guppy with editorial assistance from Dr Alexander Elder. This extract copyright 1997.

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Short extract from Chapter 11


Putting It All Together Daryl Guppy

The Greek philosopher, Aristotle, developed the concept of praxis. This describes philosophy in action. To be successful, any trading system must represent praxis at its best. You cannot trade the plan unless you have a plan, and you cannot have a plan until you can conceptualise or develop a philosophy of the market. It is similar to building a house. Before you start, you must have an understanding of what a house is, its purpose and function. Is it built just to keep the weather out or to also discourage intruders? It is the difference between an igloo and a castle. This is a philosophy that determines the design and prevents you tearing off to build a boat by mistake.


You know which tools are needed to build a house and you have watched different types of houses being built, perhaps even quizzed the builders very carefully. From this you develop a plan, gathering the tools and materials you will need. But the day you walk onto a vacant block of land and start building your own house, everything changes sturdy or ramshackle, well-constructed or tossed together, angular or curved the end result is praxis, your philosophy in action, modified by your skills and uniquely yours. So too with a trading system.


A trading system is a result, not a beginning. As traders, we want to make the best trade possible rather than the best possible trade. Pragmatic compromise with market forces more powerful than ourselves ensures survival and success. The following summary of a systematic approach to trading only makes sense in terms of the concepts discussed earlier in the book.


The methods, indicators and techniques we have discussed can be arranged in a trading system. The system has three steps, all designed to protect you as a trader while letting you take advantage of trading opportunities. These steps are:


1. Maintain updated lists of ambush sites. Good traders don't chase stocks. Like good generals, they regularly check the ambush areas looking for signs of increased activity. Do this by dividing your portfolio, or Private Index, into three lists trading stocks, active stocks, and do-nothing stocks.


2. Set the ambush. Every so often an ideal stock wanders into our ambush site. Before we spring the ambush, we use a range of indicators to make sure this is the right stock and that it will behave in the way we want it to. We want to avoid stocks that could turn against us.


3. Spring the ambush. This is the moment of action. We place the buy order and take on risk. Like riding a tiger, we need to stay on its back as long as possible before getting off without too much damage to ourselves. The process is only complete once we place the sell order.


These three steps are not mutually exclusive. There are always stocks that walk out of the ambush because we choose not to spring the ambush they are too thin or we are short of capital. As soon as you have exited a trade, you should be able to move on to the next trade quickly. You can do this if you always update the ambush sites and set the ambush, even if you don't follow through.


Maintain an updated list of ambush sites

There are three lists to be maintained in three different time frames. Stocks are moved between lists as required. Together, these lists create a single portfolio, which is the same as your Private Index.

Trading stock list. This list contains stocks that offer immediate trading opportunities; it also includes all open positions. When we exit a position, this is the list we use to see if we can immediately spring the ambush again. There might be 10 to 20 stocks in this list.


Active stock list. This list includes stocks with developing or potential trading opportunities, perhaps 30 or more stocks.


Do-nothing stock list. These stocks are doing nothing that is likely to contribute to our trading profits. They are trading sideways, or are in very long-term downtrends. These stocks have stalled. Eventually they might be dropped from the portfolio or Private Index and replaced with more interesting stocks. Many are taking a breather and will come back into play in six months or a year. This is always the bulk of stocks in the tracking portfolio.


Actively monitoring several hundred stocks is a difficult task. Many stocks don't need intensive attention, which is one of the reasons we put them in separate lists. For the same reason we split the monitoring tasks into weekly, twice weekly and daily.


Weekly monitoring

This is the most time-intensive task because all stocks need to be reassessed. This is my weekend work because it falls outside of market hours when I am not distracted by the need to monitor open positions. You might choose to do it one night a week after the market closes.


I do a quick 'kerb crawl' of all the daily charts looking for seductive chart patterns showing break-outs. I use Metastock software for this. The daily bar chart for each stock is displayed for three seconds, before flipping to the next stock until the entire portfolio has been scanned. Interesting stocks are noted. Do this until you have scanned all the stocks in your portfolio, but stick to three seconds. Why three seconds a chart? If you can't recognise a seductive break-out in three seconds, then longer scrutiny is just wishful thinking.


Stocks noted from this quick scan are analysed more carefully using point and figure charting. Some stocks are moved from the do-nothing list to the active list; others move from the active to the trading list.


Twice-weekly monitoring

In the middle of the week, the same procedure is followed with the most promising of the stocks on the active list. This does not have as much depth as the weekly monitoring, but it catches unexpected moves in a fast market. Any stock with a significant move is shifted to the trading list for more intensive daily analysis. Twice-weekly monitoring indicates which stocks should be downgraded to the do-nothing list.


Daily monitoring

Stocks on the trading list are monitored each day. The countback line is recalculated daily for each stock on the list to provide entry points for possible trades and exit points for open positions. Each stock is also evaluated by using the bar chart and the P & F chart. The results tell us if we should be setting an ambush or springing it.


A buying day means you concentrate on break-out stocks if you have trading capital to commit. A selling day tells you to concentrate on positions making a top and therefore potentially good selling points.


Each day, take out insurance against unexpected opportunities by checking stocks that have made new yearly lows. These are the surprise ambush stocks, providing targets of opportunity from the long side. Daily monitoring also indicates which stocks should be moved to the active list.


Set the ambush

At any time, there will be a number of available trading opportunities. Whether they are pursued or not depends on your cash flow situation. Good opportunities are passed up if trading capital is already fully committed; however, all trading list stocks are tracked as if there is trading capital available. This means that when a position is closed out, trading capital can often be placed immediately in a developing opportunity because the necessary research has already been done.


Once a break-out stock is isolated and identified as ready for trading, it is analysed each day using a mix of four groups of indicators. These indicators are applied over daily and weekly time frames with the longer time frame setting the direction of the trade. Each screen shows a single window and indicator. These can be grouped in split screens if required.


You may use a different mix. What is important is the way the indicators act as confirmation for each other and the way they represent a mix of oscillators, trend-following and miscellaneous indicators. In choosing your indicators, you should aim for a similar mix so confirmation can be drawn from a range of different market approaches.


Spring the ambush

The stock that walks into our ambush site may be too thin, ie, offering too little return, to bother trading, or it may be lucky and escape because we have no spare trading capital. When we decide to spring the ambush, we move to finetune the attack. The regional market we trade determines how we approach buying and selling. The best chart analysis is useless if you cannot get the price you have decided is best. How you get that price depends on your particular market.


Malaysia (short extract only)

The KLSE provides three challenges to achieving the best possible entry and exit prices. The first of these is the 30% limit above and below the close of the previous session. It is not possible to place a bid below this level to catch a falling stock. Traders must monitor the close of the previous session and if their intended entry price falls within the 30% band, they can place the order.


The second limitation is the requirement that all orders be re-keyed into the system at the end of each trading session. The only exception to this is a Good Until Done, or Day, order. The trader can place an order early in the day, as long as it is within the 30% trading band, and the order will remain in place for the full trading day. However, the Good Until Done order must be re-keyed at the beginning of the next trading session. Additionally, a market order will take priority. The trader must monitor the market carefully to catch stocks as they fall to desired levels or to sell as they approach profit targets.


The third limitation makes private and institutional trading much more difficult. Total order lots are combined at each bid-and-ask level and this makes it difficult to see where your order is within the order line. This is made more complex when orders are randomised at the beginning of each trading session. Orders entered before the beginning of trade are randomised as soon as trading opens. Your order may finish at the front of the line or at the very end of the line. You cannot tell, and this makes it difficult to decide if you should hang out for your buy or sell price, or if the bid should be changed to meet the current traded price.


You cannot afford a remisier who costs you money with poor trading executions. Develop and adopt an approach which will consistently get you in and out as close to your preferred price as possible. Work with or find a remisier who will help you trade the way you want to trade.


Thailand and the Philippines (short extract only)

Both the Stock Exchange of Thailand (SET) and the Philippine Stock Exchange (PSE) use essentially the same system, originally developed by the Chicago Stock Exchange. The SET also sets a 30% floor and ceiling limit based on the close of the previous session. Orders remain in place all day and unexecuted orders must be re-keyed for the next day. Most private traders will need to reinstruct their brokers to place orders the next day.


New pre-open orders are keyed in from 9.30 am. At the open of trade, brokerage houses send all their orders at once. The software used by your brokerage house will decide which orders are listed at the head of the line; thereafter, orders are executed on a time and price priority.


Traders using screens provided by their brokers can see three spreads either side of the current trade. Total lots sought at each level are shown and the only way to track your order is by lodging it after the open.

Position traders relying on end-of-day data will use day orders in the same way as a Good Till Cancelled Order in other markets, but remember the order is only good for the day. When prices have closed at your buy or sell point on an end-of-day chart, an 'At the Open' order becomes an effective way of trading. Stocks with steady liquidity are ideal candidates for 'At the Open' orders and traders can execute position trades based on chart analysis with a higher level of certainty but still within the 'Last Gasp' limits.


Hong Kong (short extract only)

Achieving a chart-indicated entry price is complicated in Hong Kong, as all unexecuted orders are removed from the screen at the end of each trading day. These orders must be re-keyed at the open on trade on the next day. Pre-keying orders in advance is not permitted, so those using brokers with fast typists have a slight advantage in getting towards the head of the order line.


Another slight advantage in buying the open may be gained by asking your broker to have the order executed on the floor of the trading hall of exchange by their representative. Floor trading is also by screen matching. Generally traders just have to accept what they get in terms of buying the open matching trade.

The Stock Exchange of Hong Kong (SEHK) does offer advantages in the depth of market information, as a broker's screen shows the members' codes beside each bid and ask. This allows the trader to track the progress of his order towards the head of the line.


Some brokers will accept stoploss orders, although these are noted by the broker either in a daily diary or on internal software and not by the SEHK trading system. The broker will execute the stoploss as instructed, on a 'best endeavour' basis or ring the client. This involves a lot of work, so while this facility is generally not available to small private traders, high net-worth individuals can expect it.


Because all unexecuted orders are removed from the system each day, the use of limit orders to achieve favourable long-term entry positions has reduced effectiveness.


To avoid the temptation to chase prices, some traders use a discretion limit order. The limit can be based on a tick range or on time. The advantage of this type of order is clear in a rapidly moving market. The instructions to your broker can include a tick range outside the current spread. With this latitude, the broker can execute on a 'best endeavour' basis.


Alternatively, the private trader can follow the institutional example and look for a fill over the day on a weighted average execution. This type of instruction, like a stoploss order, involves more work as the broker must monitor the client's stock; most brokerage houses will not do this for small private traders.


Singapore (short extract only)

Unexecuted orders at the end of the day are cleared from the screens. All orders are re-keyed in the morning at the open of trade. All new trades are executed at the same time and the fastest typist wins.

With perhaps orders for 200 lots to key in, the broker must make a decision about where he starts. Realistically, large-size orders are keyed in first; smaller, private clients or infrequent traders tend to be keyed in last. However, once the market has been established, the private trader can get ahead of size because the broker enters orders on a strict time basis.


Trading is made easier by fully scripless trading apart from a few foreign listings and the move towards EPS settlement in a trade-plus-three environment. The old trade-plus-seven calendar days to settle encouraged many contra-traders. The practice of essentially buying on credit and hoping that the broker would conclude a forced sale of the counters for a profit by the eighth day will be curtailed by the move to trade plus five, and virtually eliminated when trade plus three is introduced. EPS settlement gives active private traders the opportunity to move funds out of brokerage trust accounts, where they earn no interest, into linked bank accounts which do earn interest.


Traders can track their order as an addition to the lots wanted at each level, or by asking their broker for 'order done' or course of trades information. At best, this allows the trader to infer his position in the line. This inference is not always correct, particularly if orders are withdrawn before they are executed.


Effectively trading this market involves setting entry and exit points a tick or so away from the ideal. With a good broker or remisier, market orders or discretionary limit market orders can be executed close to the desired level. When trading 'at market', your broker should tell you on the phone when the trade is done.

A large brokerage house may offer competitive commission rates, but this advantage is soon eaten up with poor trading executions. A smaller brokerage house with a good private client focus may make you better money with better fills.


Slippage, the difference between the price you want according to the screen and the price you actually get, should be factored into any trading calculations.


Indonesia (short extract only)

At the open of trade, all orders are phoned through to the floor traders poised in front of their terminal screens at the Jakarta Stock Exchange. Market orders are entered first, led by size. Limit and discretionary orders follow, and last of all, any Good Till Cancelled orders. The open is set by the first matched trade, or is displayed as the last trade done on yesterday's close.


Orders entered during the trading session are phoned through on a strict time priority, so private traders can get ahead of size if the order is filled during the day. The brokers order slip is time-stamped and orders are phoned through to floor terminals at this time. In a fast market with lots of activity, brokerage houses keep the phone line open to their floor traders.


Limit orders placed on a daily basis are the most effective way position traders can chase fills. You should balance the need to execute at a preferred price against the probability of a favourable position in the order line the next day.


In these types of markets, where full and detailed depth-of-market information is not available, traders can always guarantee fills by bidding one tick above market or asking one tick below market. When prices hover around target areas based on chart analysis, taking this slippage may be the best way of ensuring a position is established or exited. When you ask your broker for depth-of-market information, make sure you get both the total lots wanted and the number of brokers chasing stock.


Buying in order-driven markets

The regional markets are all order-driven trading systems, matching buy orders with sell orders, usually based on time and size. Orders are executed on a strict price and time priority; an order entered into a system at 8.30 am must be executed before an order at the same price entered at 8.40 am is executed. These trading rules allow private traders to compete with the institutional traders, but in some order-driven markets, these outcomes are distorted when size is given a priority.


Within the constraints of the rules imposed by each regional trading system, we must set general objectives for trading execution. Three general points always apply. First, when brokers are required to key in all orders on the market open, inevitably the most valuable clients, the largest position size, get done first. This is not a problem with randomised opens. Look for order execution consistent with your size.


Second, in a fast market, size gets done first or even worse, broker third-party trades are done first so factor this into your trading calculations. It is in your interest to know if your broker is also an active trader, for although the client comes first, occasionally the client does come a poor second. A broker without this distraction can concentrate more fully on executing your order.


Third, tracking market depth when only consolidated lot figures are available is sometimes distorted by orders that are withdrawn as they approach execution.


The size of our position is determined by the money management method we use. Such methods are discussed in chapters 12 and 13.


All buy conditions must be confirmed: trend break-out as shown on the P & F; countback line break-out as calculated; and all other indicators showing support for or, at the very least, no opposition to, the buy. Before you take another step, you must know your preferred price, the Last Gasp price and the forget-it price.


Where possible, we want our preferred price either on the day, or by setting the trap in advance using a Good Till Cancelled or limit order. Exactly how you achieve this depends on the rules of your market.

Where possible, use a real-time screen or ring your broker or remisier for the same information. When you get it, put the phone down. Analyse the information without pressure, then ring him back to place the order. This is your buying decision, not his.


Even if your Private Index indicates a buying day, give the market 20 minutes or so to set its initial, and usually, daily direction. A down-day is an unexpected bonus because you can enter even lower than your preferred price.


On a down-day, you might hold out for a price lower than your preferred price, or haggle somewhere inside the current bid/ask spread. On an up-day, you might meet the seller, hopefully below your Last Gasp price. Every tick up or down affects your expected return, so know your limits before you phone the broker back with an order best suited to current market conditions.


If you have depth-of-market information how many sellers and buyers at each price level use this to further finetune the entry. Typical depth-of-market information is shown in figure 11.10. If your preferred buy price is 76, but there is a massive buy order in front of you that is soaking up sellers, then bid 77. You will be filled, and the big buyer at 76 will provide a temporary support level.

Phone through the buy order. With nationwide electronic trading where buyers are instantly matched with sellers (and if you are meeting the sellers, ask a tick above the market), the broker should be able to confirm the trade before you hang up.


If your remisier is reluctant to provide service at this level, carefully consider how it impacts on your trading and adjust your approach accordingly. Once you have a position, it needs monitoring immediately.


Selling in order-driven markets

Deciding when to sell involves many of the same procedures as deciding when to buy. The decision is based on three factors:


1. The price level is equivalent to 2% risk of equity on the downside. When prices reach this level, you should be out immediately. If prices fall below this, get out anyway. The first loss is usually the cheapest. The best way to save face is to exit early.


2. Profit objectives are achieved. If you are in the trade for 10% return, then exit at market when it is achieved. If you must stay in the trade, do so only if the countback line and the P & F charts are screaming, 'Stay, stay!' Generally, it is safer to walk a mile with the crowd and leave the insurance money on the table when you leave.


3. When other indicators call a trend reversal or suggest a top, exit whether or not profit objectives have been achieved. Use the countback line technique to finetune the exit if appropriate, but do not delay. Prices can rise on a gust of market wind, but they feel the full effects of gravity when they fall.


Use a real-time screen or ring your broker or remisier for the same information as you would when making a buy decision. When you get the information you need, absolutely, definitely, put the phone down fear clouds judgment faster than greed. Ring the broker back when you have looked at the data and made your decision.


A selling decision is often more difficult than a buying one. This is very much your decision, not your broker's, so rely on your judgment.


Think about holding out for a higher, Last Gasp price or take the middle ground between the ask/bid spread if the market is making an up-day. On a down-day, meet the buyer quickly before you pass the 'abandon it' price. Stocks tend to tumble faster than they rise. Every tick up or down affects your return, so know your exit price limits before phoning your broker with the sell order.


Use depth-of-market information to make the best exit possible. If your preferred sell price is 106, but panicked sellers have clustered at that level, flooding the buyers, then ask 105. When you are filled, the sellers at 106 will hate you but the consolation prize in a falling market is money in your account.


Phone through the sell order. In a fast-falling marketplace, sell a tick below the market. In a fast-rising market, I monitor it frequently, ready to meet the most enthusiastic buyer with a limit sell order. Nationwide electronic trading gives you the opportunity to finetune the exit. Meet the buyer's bid and the broker will confirm the trade immediately. If you are riding a loss, you need to know the damage immediately so you can take appropriate action.


Develop and adopt an approach which will consistently get you in and out as close to your preferred price as possible. Work with or find a remisier who will help you trade the way you want to trade.


SEATS for all

Effective markets must be transparent. Transparency comes when the relevant information is available cheaply to all participants. Secrecy has no place in the market. When large orders can hide in a consolidated lot size, it deprives others traders of valid information and opens the door to market manipulation. When good trading analysis and judgment is rendered ineffective by the lottery of new orders on every open, the market encourages gambling. This interferes with the efficient allocation of capital and the effective management of risk within the economy.


Of all the Asia-Pacific exchanges, the Australian Stock Exchange offers perhaps the most favourable trading environment for private traders. The Stock Exchange Automated Trading System (SEATS) uses the power of computer networking to create a level trading field. Most brokers have a SEATS screen in front of them, and orders are keyed directly into the system for automatic matching or for future execution at prices close to or well above or below the current trade. The spread is limited by generous percentage ranges, making the bid and ask for 15 or 20 ticks available in each direction.


Readily available cheap Internet screens give private traders full access to depth of market, including the ability to track individual orders, as shown in figure 11.11. Apart from the identifying brokerage house codes, these are the same screens the broker sees. This transparency makes it more difficult to manipulate the market, as individuals, institutions or syndicate groups cannot hide behind a consolidated number of lots.

Superior market analysis is properly rewarded, as all unexecuted orders including Good Till Cancelled orders remain on the screen, in the same line position, over multiple trading sessions without the need for re-keying. Orders are executed on strict time and price priority, including orders left over from the previous trading session and orders keyed in at any time before and after the open of trade. Traders who make better judgments earlier than their competitors can turn this to a profit by placing long-lasting orders in the system and retaining their position in the execution line. The ability of size to bully the market and brokers is reduced. Under these conditions, trading becomes more exact as the lottery element of randomised opens or a keyboard race from a standing start are removed.


Despite these trading system advantages, the punitive tax regime in Australia makes it less attractive for direct trading than other Asian countries. Although it has the cleanest and most transparent of all trading systems, the ASX will be relegated to a financial backwater in Asia-Pacific until it can match international competitiveness in the areas of brokerage and taxation. Until then, the SEATS system provides the benchmark against which traders in regional markets can compare their own systems.


No matter which exchange you trade, the objective is to make an entry or exit as close as possible to your preferred price.


There is no universal trading system. The systematic approach described above is universal only in that it shows how method, indicators and techniques need to be related in a coherent and consistent approach to the market. This chapter has only summarised the process and shown you an example of praxis in the market. Your challenge is to apply the process and produce your own example.





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