Rules of the Trade: Understanding the Bigger Picture


Aug 18, 2006
It is estimated that 90-95% of all futures traders lose money in the markets. Most traders deplete their trading account within the first 6 months. Out of all who survive past the first 6 months, 50% of them will never make it beyond 12 months. Why are these stats so low? And why am I not surpised?

Let me explain: Most market participants enter the market without much knowledge of how the markets function. It is common to see successful lawyers, doctors, and businessmen enter the market just to lose their entire trading captial. As a trader I am in the business of risk. Without this in mind you are doomed to fail. Trading and investing are not primarily about picking hot stocks, using the greatest technical indicator, or following a trading system. The only holy grail to trading is strict self-discipline and money management.

Top reasons why traders fail:

1. Lack of market understanding
2. Being undercapitalized
3. Too much leverage
4. Not understanding trading mechanics: tools of the trade
5. Not having an edge
6. Lack of self-understanding: unaware of your own pyschological components
7. Lack of passion

Many trading/investment textbooks will tell you to seek out for low risk:high reward trades without telling you how. There is a reason why they are authors and not traders. Low risk:high reward do not always exist. But what I would like to explain in this thread is identifying high probabilitiy trades. Of course these setups can not be identified easily. A trader must gain tremendous market knowledge and insight to identify these high probability setups. The markets are an auction between sellers and buyers. The only factor that will cause a market to trend or consolidate is market balance and imbalance. It is a simple law of supply vs demand. Many traders will become too absorbed in the tick by tick intraday action. What they lack is seeing the bigger picture. Most of the intraday action is noise. The ability to filter out noise from key information is an important element in trading success.

Undestanding the bigger picture: Ask yourself two important questions when trading the markets.

1. Which direction is the market trying to go?
2. Is it doing a good job trying to go in that direction?

When the markets are consolidating, confidence among buyers and sellers are balanced. When one side expresses greater confidence, this will create a imbalance of supply and demand causing the markets to trend or enter a new price zone. What is important to understand is this: Is there market acceptance or rejection in the current price zone? Value area or value refers to the price zone in which approx 70% of the volume took place the previous day. Value high is the upper pivot of this range and value low is the lower pivot of this range. If the markets trade within value, this indicates a market in balance. If the markets trade outside of value, this indicates market imbalance. This is a important concept to understand when trading the futures markets. If prices are trading outside of value but pushed back into value, this indicates price rejection outside value. If price is trading outside of value but remains in value, this indicates price acceptance in the new zone. Usually the markets will consolidate when trading inside of value. If the markets breakout to the upside, the value high pivot will act as a key support and if the markets breakdown below value the value low pivot will act as key resistance.

High probability trading exists once you fully understand market acceptance vs market rejection and balance vs imbalance. This is the bigger picture. Once you grasp the bigger picture, you will need to look at the micro view of the markets. This involves identifying key pivot levels that will act as significant support and resistance. As an intraday trader, I will always identify: yesterdays low, yesterdays high, yesterdays 50% range, daily pivots, weekly pivots, monthly pivots, value high, value low, and POC (point of control). The POC is simply the price where most volume occurred the previous day. By doing this analysis I will get approx 25-30 different prices. I will then take these pivots and look for cluster zones. A cluster zone is any price level in which 2 or more pivots line up with each other.

For example: if yesterdays high was 11400 and the value high pivot is at 11395, this area would be a key pivot point cluster zone.

In any given day, there will be 2-5 pivot point cluster zones to look at. These are the high probability trading levels. If the markets are trading above value and there is acceptance, I will look for a long setup at these cluster zones. If the market is trading below value, I will look to short these cluster zones. If the markets are trading within value, I will look to fade any cluster zone.

These are just the basics of trade setups using pivot point clusters. In order to trade this method successfully you must understand what the market is doing. There are several market internal tools that you can use to identify the pulse of the market. They include: TRIN, TICK, put/call ratio, and PREM. Explaining these different tools will go beyond the scope of this thread. Feel free to contact me if you need help understanding any of these tools and trading methods I have explained here.

I hope this information helps. Good luck and best of trading.
Wow!!! :thumbup: Thats great stuff!! Im just starting out and im going to reread that again! I noticed you didnt really mention diversifying and i would love to hear your take on that.