5 Pillars of Active Trend Trading Pillars 4-5

Timing is More Important than Price. ~~ W.D. Gann

Dennis W. Wilborn

Disclaimer

U.S. Government Required Disclaimer – Commodity Futures Trading Commission Futures and Options trading has large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in the futures and options markets. Don’t trade with money you can’t afford to lose. This is neither a solicitation nor an offer to Buy/Sell futures or options. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed in this training. The past performance of any trading system or methodology is not necessarily indicative of future results. CFTC RULE 4.41 – HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN. All Materials presented are for training purposes only . Traders should paper trade any new method prior to risk of personal capital.

5 Pillars of Active Trend Trading

Sound Trading Systems tell us:

4. Strategy to Use – Or when to apply our Strategies

5. What to Expect

The last 2 Pillars are often either overlooked by traders or ignored.

Strategies without the Foundation of the System are prone to Failure!

Systems & Strategies without knowing the Expectations is like being in the Fog. No Landmarks to let you know how you’re doing!

Pillar 4 & 5

Strategies from in increasing levels of complexity due to more

variables and knowledge requirements

1. Buy & Sell Stocks and ETF

2. Buy & Sell Options

a. Covered Calls

b. Directional Options

c. Spreads (debit & credit/Vertical, Diagonal, Calendar)

d. More Exotic Option Trades (Iron Condors, Butterflies,

Straddles, Strangles and more.)

3. Futures & Forex

4. Others (Mutual funds—not complex just no control)

Pillar 4

Stocks & ETF’s: Buy & Sell based off of proper Action Points from the System.

Variables:

o Stocks

o Earnings

o News

o Index ETF’s (bullish)

o No Earning Surprises

o News

With a Margin Account can be leveraged up to 2-3X depending on the stock and broker

Pillar 4

Options: Buy & Sell based off proper Action Points from the System

Attraction: More Leverage with small account! Some times the Attraction is Fatal! Leverage is a two edged Sword!

Fact: Greater Reward/Greater Risk than trading stocks/ETFs

Variables: Many more variables—must be MORE RIGHT!

For a trader who is anchored to a great system trading options can work very well, but many jump into option strategies without being successful in trading stocks/ETF’s.

The allure of turning small money into big money blinds them to the downside risk—They buy cheap out of the money option on a hope and prayer it will run up, but……it expires worthless!

Pillar 4

• Futures & Forex: Similar Challenges as Options but often with great leverage. Requires more skill and potentially more time to trade.

• Fact: Even Greater Reward/Greater Risk than trading stocks/ETFs

• Others (Mutual funds—not complex just no control which is a different kind of risk)

Regardless the strategy, knowing and using a sound trading system is critical to successfully applying the strategy.

Too Many Trader focus on just the strategy and this is hazardous to the health of the trader’s trading account!

Pillar 4

How do we define expectations for a Systems?

What are the most important characteristics to define?

Which of the following is most important?

Winning %

Losing %

Number of Trade

Size of winning trades compared to Size of losing trades

Defined Expectancy (How much you can expect to make per

trade on average)

Pillar 5: Expectations

While each of the preceding elements are important some are

more important than other in defining the Expectancy of a

system.

Lease Important: Winning % and Losing %

More Important: $ gained per Win & $ lost per loss

Expectancy and Win/Loss Ratio

Pillar 5: Expectations

Lease Important: Winning % and Losing %

Example: A system that has 70% winning trades, sounds great but.. What happens if each winning trade gains less than each losing trade loses?

Average Winning Trade Gains $100

Average Loosing Trade looses $400

Out of 100 trades

70 winners x $100 = +$7000

30 loses x $400 = -$12000

Net Gain/Loss = - $5000

The system would have a Negative Expectancy and thus not a good system

Pillar 5: Expectations

Lease Important: Winning % and Losing %

Example: A system that has 40% winning trades, sounds great but.. What happens if each winning trade gains less than each losing trade loses?

Average Winning Trade Gains $400

Average Loosing Trade looses $100

Out of 100 trades

40 winners x $400 = +$16000

60 loses x $100 = -$6000

Net Gain/Loss = + $ 10000

The system would have a Positive Expectancy and thus system worth checking out

Pillar 5: Expectations

Most Important: Win/Loss Ratio & Expectancy

Psychologically a system with less than 50% winners might be challenging to trade!

Win/Loss Ratio =

(Total of Profitable Trades/Number of Profitable Trades)

(Total of Losing Trades/Number of Losing Trades)

From the past example of 40% winners

(Total of Profitable Trades = $16000/ Total Profitable Trades = 40) = $400

(Total of Losing Trades = $6000/ Total Profitable Trades = 60) = $100

Win/Loss Ratio = 400/100 or 4:1

For every dollar I risk I have the potential to gain $4

A system with a W/L Ratio of > 2:1 is very good

Pillar 5: Expectations

Most Important: Win/Loss Ratio & Expectancy

Expectancy: Tells us how much we will like earn on each trade & we want this to be positive greater than zero

Expectancy = (Ave Profit X % of Winning Trades) – (Ave Loss X % Losing Trades)

From the 40% example:

Ave Profit = $400

% Winning Trades = 40%

Ave Loss = $100

% Losing Trades = %60

Expectancy = (400 x 0.4) – (100 x 0.6) = $100

So over time we could expect to earn $100 per trade

Neither of these calculations answer the questions of trade frequency per year or how much capital is required. Frequency is a function of what entity is being traded.

Pillar 5: Expectations

The Active Trend Trading System over 10 years trading SPY Long

Average Winning Trades = 72%

P/L Ratio: 4.4:1 average over 10 years

Expectancy : $193.64 per Trade

Average Trades per Year: 16.70

On a $10,000 account trading only Long SPY

Ave Profit per Year = 16.70 x 193.64 = $ 3233.79

Ave Return Per Year = (3233.79/10000 ) x 100 = 32.34%

Pillar 5: Expectations

Summary

Learn the system before apply the strategy

Start with the simplest Strategy

Know what to Expectations on each trade