In the efficient market theory, people buy and sell on the basis of their knowledge, so the latest price represents everything known about the market. Since everyone has the same information about market, the price should reflect the knowledge and expectations of everyone. Therefore no one should be able to beat the market since there is no way to know something about market that is not already reflected in the market’s price.

Because markets know everything and no one can beat them, trading is like playing chess against someone who knows more than you. Hence, do not waste your time and money, just trade simply by indexing your portfolio and selecting securities based on volatility.

However, there is ample evidence to dispute the basic claims of this theory since there are traders who constantly and eventually make money, what about them?

The efficient market theorists say that winners are plain lucky. Most people make money at some point, before bleeding it back into the markets.

This is obviously incorrect. Because there are people who keep outperforming markets year after year. One of them is Warren Buffet, brilliant traders, says that investing in a market in which people believe in efficiency is like playing poker against those who believe it does not pay to look at cards.
Besides the efficient market theory, there is one of the largest pieces of theoretical garbage. The theory correctly observes that markets reflect the intelligence of all crowd members.

Most traders can be rational when the markets are closed. They calmly study their charts and decide what to buy and sell, where to take profits, and when to cut losses. However, when the markets open, they don’t trade their plans.

Trading is partly rational and partly emotional. To be a successful trader you must keep your cool at all times and take money from aroused amateurs. People are more likely to be rational when alone, and grow more impulsive when they join crowds.

All the while, the intelligent trader follows his rules. He may use a mechanical system or act as a discretionary trader, reading his markets and putting on trades. Either way, he follows his rules rather than his gut. That is his great advantage.

That’s why traders must always operate within various time frames. The most profitable positions will align to support and resistance on the chart one amplitude above the trade and display low risk entry points on the chart one amplitude below.

Price evolves through bull and bear conflicts in all time frames. When ongoing trends are not in gear with specific charting periods, trade preparation may become subjective and dangerous.

The perfect opportunity to enter a trade rarely exists. An obvious breakout on one chart may face resistance on the longer-term view just above a planned entry level. Or a shorter-term chart may display so much volatility that any entry becomes a dangerous enterprise.

Successful trading needs a careful analysis of conflicting information for entering a trade only when favorable odds rise to an acceptable level. If you face with a good setup in one time frame but marginal conditions for those surrounding it, use your experiences and skills to evaluate the overall risk. If risk/reward ratio is in a tolerable range, consider execution even if all factors do not favor success.

However, chart information priority parallel chart length. For example, major highs and lows on the weekly chart carry greater importance than those on the 1-hour chart.

Profit opportunity aligns to specific time frames. This trend relativity error often forces a new position just as the short-term swing turns sharply against the entry. Trend relativity errors rob profits on good entries as well. No one wants to leave money on the table. Natural wave motion may whipsaw the position sharply and sends the trade into a substantial loss well before reaching a reward target.

Most traders should never change their holding period without detailed pre-planning. Specific time frames require unique skills that each trader must master with experience.

Begin with a sharp focus on the next direct move within a predetermined time frame. Prepare a written trading plan that states how long the position will be held and stick with it. Establish a profit target for each promising setup and then reevaluate the landscape that price must cross to get there. Consider the pure time element of the trade. Decide how many bars must pass before a trade will be abandoned, regardless of gain or loss.

Each time frame attracts a specialized group of traders that interacts with all other groups through the universal mechanics of greed and fear. This results in trend convergence, divergence through different time lengths. Successful traders improve performance when they adjust their chart view to match the chosen holding period.

Successful trade execution aligns positions through several time frames. By doing this, first choose a primary chart screen that its time frame reflects the holding period and matching strategy. Then study the chart one magnitude above that period to identify support, resistance and other landscape features that impact risk/reward ratio. Lastly, shift down to the chart one magnitude below the primary screen and identify entry points.

The trading system that uses three different time frames, defined by Alexander Elder in his book “Trading for a Living”, is called Triple Screen System.

Time frame analysis above and below the current setup chart will identify opportunity and risk in most cases. For example, when a promising setup appears on a 1-hour chart, a trader checks the daily chart for support and resistance but uses the 5-minute chart to time execution to the short-term flow of the market. This approach works through all time levels.

Amateur traders routinely fail at time management. Many never identify their intended holding period before they enter a trade. Others miss major support and resistance that appears on the next above magnitude chart. Some sit on nonperforming positions for weeks and tie up important capital while excellent opportunities pass by.

In all cases, time works as efficiently as price since all time frames display unique properties that enhance or damage the odds for profit.

Every opportunity arrives with a time shadow hanging over it.  You have to focus attention on important feedback at the exact time that the information will likely impact that market. It may offer an execution window that closes in minutes or offer an exit that should be taken immediately when it arrives.

Successful traders must manage time as efficiently as price. Use both price and time triggers for stop loss management. Time should activate exits on nonperforming trades even when price stops have not been hit. Execute only when time bias improves the odds for profit.

In trending market, fast-moving stock’s prices attract attention and awaken great excitement. Many novice traders fever with these hot plays. The financial press makes these more danger with frantic reporting of big gainers and losers. But gaining profits by momentum trading requires great skill and discipline.

Typically, price seeks equilibrium.  When unsettling events destabilize a market, counter-trend force emerges quickly to put it to a stable state. This inevitable backward reaction follows each forward impulse. Novice traders fail to consider this action-reaction cycle when they enter momentum positions. They blindly execute trades that rely on a common but dangerous trending-following strategy, then trend reversals appear suddenly.

Novice traders enter small price swings on the false assumption that the action represents a new breakout for a major trend. Although these errors may not incur large losses, they damage equity and confidence at the same time.

Some traders, in the other hand, may appreciate the market’s complexity and realize that trading mastery requires many diverse skills. As price usually cycles through regular phases, strategy needs to adapt quickly to capitalize on the current crowd. So, swing trading, that execute right near support or resistance, is a powerful alternative. This classic trading style requires more precise planning than momentum. However, it allows measurable risk and highly consistent rewards.

Swing traders seek to exploit direct price thrusts as they enter positions at support or resistance. They analyze chart pattern characteristics to indicate short-term market inefficiencies. The swing trading strategy is a time frame independent methodology. Some traders are able to apply this strategy by never holding a position overnight.

Nowadays, the revolution in high-speed trade execution opens swing strategies that last for minutes instead of days. Dependable price patterns appear on charts in all time frames, swing setups offer the short-term charts the same opportunities that appear on longer-term charts.

Swing trading provides a natural framework to identify changing conditions and apply new methods to exploit them. However, as its core, swing trading is not the opposite of momentum trading. During the times that strong price movement characterizes a market, disciplined momentum strategy becomes the preferred swing trade. In this way, modern swing traders can apply the principles of risk management and price boundaries and use momentum’s greed to their advantage.

Channels help traders because their boundaries show where to expect support or resistance to come into the market.

Support is where buyers buy with greater intensity than sellers sell. Resistance is, in vice versa, where sellers sell with greater intensity than buyers buy. Channels show where to expect support and resistance in the future.

Construct a channel

There are several ways to construct a channel. Here, let’s see the four simply ways.

1.  By drawing a channel line parallel to a trendline. The channels parallel to trendlines are useful for long-term analysis, especially on the weekly charts.

2.  By drawing two lines parallel to a moving average, one above it and another below. The channels around moving averages are useful for short-term analysis, especially on daily and intraday charts.

3.  By drawing two lines parallel to a moving average just the same as above, only the distance between each line and the moving average changes depending on the market’s volatility. This kind of channel is well-known as Bollinger bands.

The channels whose width depends on volatility are good for catching early stages of major new trends.

4.  By drawing a moving average of the high price of bars and another of the low prices of bars.

Besides the boundaries of a channel, its slope can be used to identify a market’s trend. When a channel lies flat, you may trade all swings within its walls. When a channel rises, you should trade only from the long side, buying at the lower bound and selling at the upper bound. When a channel declines, you should trade only from the short side, shorting at the upper bound and covering at the lower bound.

In some kinds of channel, the width of channel depends on the coefficient selected by traders.

For example, a moving average channel can be drawn as follow.

Upper Channel Line = EMA + Channel Coefficient EMA
Lower Channel Line = EMA – Channel Coefficient EMA

However, you need to adjust channel coefficients until a channel contains 90 percent to 95 percent of the price action. As the normal prices should be inside a channel and only unusual events push them outside.

Adjust channel coefficients at least once every three months to make a channel contain 90 percent to 95 percent of prices.

If prices keep bleaching out of a channel and staying outside for more than a few bars, that channel should be widened.

Also, if there are too many reversals within the channel without reaching its boundaries, that channel should be tightened.

Amateur traders think that they can fix a strategy through optimization. They think that even if a strategy loses money, they can fix it by optimizing the lengths of the indicators. It is wrong. Optimization should never be used to make an unprofitable strategy viable. It should make a profitable strategy more profitable. It should only be used for tweaking the profits. Optimization should never be used to make a bad strategy good.

When you have designed a viable strategy and improved it through optimization. You are now ready to trade the strategy. If you are truly going to run our trading like a business, you have to implement the strategy as designed. Do not beat the strategy, try and second-guess the strategy, by personally filtering the trades based on your own ideas.

Corrupting the strategy through filtering trades with personal bias is a major problem that beginners face. There are many possible distractions during the trading day, unusual market action, and important breaking news and etc. But reproducing the strategy in real time is a bad idea. You have to trade it exactly as it has been designed and tested in the past. The distractions during the day may make it difficult to implement the strategy exactly as it was designed.

If you have trouble putting on your trades as your strategy, you should make sure that the characteristics of the strategy fit your own trading style, that you can accept the risk and drawdown and comfortably take all of the losing trades. If you cannot take the losses and drawdown, you must either fix the strategy or find a new one that is more in harmony with your personality.

A characteristic that stops share with exits is they force the strategy out of the market, which then requires a re-entry. We should give this re-entry caused from stops the same thought and attention that you would give a re-entry for exits.

The first stop we should consider is the stop to limit your losses or money management stop. This type of stop define the maximum amount of money that you are willing to risk on any one trade. It must be placed after the initial entry and must not be moved. The decision to place this stop is dependent on the strategy.

One thing to remember is that the volatility of markets changes over time, and what has been a good money management stop for the last few years may not be appropriate now. So keep in mind that if you use money management stops, you should keep testing for the appropriate level. You will know that your stop is not appropriate when you get stopped out of a move too early because your stop interferes with market action.

Another stop you should consider is the profit protection stop, trailing stop. It protects profits once the trade has moved in profitable direction. A trailing stop keeps moving with the profits. For example, in a long trade, if the price has moved up in your direction, you would also move the stop up.

Money management and trailing stops can also be combined to limit the total risk of any one trade.

For example, the initial stop loss might be $1,000 away from the entry price. This limits your loss in the worst case scenario to $1,000. Once the strategy moves into profitability, a trailing stop is placed $1,000 away from each day’s closing price. When the profit reaches $1,000, your trailing stop would be at break-even. If the price continues up, it would result in the trailing stop being moved up to protect even more profit.

The use of a stop depends on your trading style and risk aversion. However, stops are less important if you have spent the time and energy to develop a sound set-up and entry strategy. The use of stops will not make a poor set-up and entry strategy sound.

For the exits, in theory, we may use reversing of signal to define the exit. For example, if you use trend-following strategies and you enter a long position according to the set-up and entry tell you, then you me exit the market when the set-up and entry tell you to go short.

However, if you find an indicator or signal that tests well, you can improve on it by using various exit strategies. There are various reasons to use an exit rather than just reverse a position.

The most common is you can take a profit at a predetermined price level or indicator level. This would be a profit objective.

Another reason would be when you are writing a strategy that is based on several indicators (perhaps two set-ups and an entry), all indicators must be in gear before a position is taken. When one or two of the indicators turns against the position, the strategy exits the market, waiting for the three indicators to agree again.

One of the most common errors in strategy design is when traders use either the set-up or the entry as an exit. The use of an exit is less important if you focus on the concept of set-up and entry because the set-up and entry technique is very effective by itself. So, using either set-ups or entries as exits is not the recommended thing to do.

Exits must based on market activity. Exits must not be designed to save you money or protect your capital. That is what we have to stops for. Exits should be used to increase your profits.

Exits may be more appropriate for short-term trading strategies, such as volatility expansion strategies or support and resistance strategies, than the long-term trading strategies such as trend-following strategies. Since the short-term trades can take advantage of short-term market conditions.

For example, in a volatility expansion strategy, we wait for the next increase in volatility and then enter the market. We would then devise an exit that would get us out of the market when the volatility increase had run its course. Or, when we had achieved our profit objective.

While in trend-following strategies, we must be sure that if the exit rule gets us out of the market, the entry makes sure that we are back in for the big move for which the strategy is designed. Sometimes using an exit signal prevents a timely entry back into the market, and the strategy misses the next move.

Indicators are the backbone of the strategy. Most Trading Software, such as MetaStock or TradeStation, have included indicators library. Many of the standard indicators are found in their library. They also allow traders to adjust, optimize and create their own indicators as well.

You may notice that most indicators (if not all) are price based. By saying price based, it means most indicators are calculated by using some number from a price bar; the open, high, low, close. Therefore it may look very similar on the same chart.

One thing you should understand is that most indicators that are based on the same prices, e.g. the close, look about the same. Many new traders try to combine indicators that are based on the same data. This leads to unnecessary redundancy and duplication.

So, if you you want to combine and use multiple indicators in your strategy, try to combine indicators that are based on different prices. For example, you might combine an indicator based on the close with an indicator based on volume, or with one based on volatility.

Since almost any price activity can ultimately be made into an indicator. So, if you want to create your own indicator, all you need to is just to draw a line with quantifiable data and name it.

Price Patterns

In addition to indicators, there is a type of trading method that is commonly used among traders. It is price patterns. The concept of this method is that you identify specific price patterns and trade them.

For example, let’s consider a simple and easy pattern to understand, the consecutive closes. Trading this pattern maybe just buying the market after three consecutive up closes and sell after three consecutive down closes. Although it is a simple price pattern, you can make them as complex as your imagination allows.

For example, you may formulate a buy signal after the price forms up-down-up pattern, which is; today’s close price higher than yesterday’s close price, yesterday’s close price lower than the close price of the day before, and that close is greater than the previous close. In vice versa, you may formulate a sell signal after the price forms down-up-down, which is; today’s close price lower than yesterday’s close price, yesterday’s close price higher than the close price of the day before, and that close is less than the previous close.

Firstly, you have to decide decide whether you will trade intra-day or not. If you trade intra-day, you will become a day-trader that means trading full time. It may be possible to trade intra-day while yiu have a day job but it is very difficult. So, I would not recommend that you to trade intra-day unless you can devote your full attention to trading.

Generally, most people want to trade only part time and still hold down a day job. Therefore, it is better to trade daily or weekly charts. Since you will only be able to look at the market after hours so you have to take this into account when you do your strategy design.

The designed strategy should not require checking the market during the day. However, I believe that the more bars you can trade, the more money you can potentially make. That means trading intra-day is potentially more profitable as there are more bars condensed into a unit of time.

For example, in a period of month, there are 280 bars in 30-minute charts, 20 bars in daily charts, 4 bars in weekly charts and only 1 bar in monthly charts. So, there is potentially more money in the 30-minute charts than the daily charts, potentially more money in the daily charts than the weekly charts, and potentially more money in the daily charts than the monthly charts.

Then, to make $10,000, it should take less time on the 30-minute chart than the daily chart, weekly and monthly chart. When trend trading on 30-minute charts, you may trade
through 5 or 10 days of directionless market before the relatively big move occurs while on a daily chart, the chop may last six months or longer, and on the weekly charts the sideways market could last for years.

In addition, the risk per trade is generally greater when you trade with the longer time frames. Most entries and exit orders are based on market action. Since we usually put an exit order
below the low of the previous bar, this could be 30 points on a 30-minute chart, 500 points on a daily chart and 1500 points on a weekly chart. The difference in risk is substantial, but the reward should be proportionally as large.

There are no right answers in choosing the time frame. It depends on a personal decision. And you have to make this decision before you start looking for indicators, as the choice of indicators is influenced by the time frame selection.