Ask Al: China Futures Daily Q&A Part 2

China Futures Daily Q&A: Part 2 – Q8 to Q12

Al Brooks leaves for his China lecturing trip later today. Sadly, the exact schedule is still not finalized and details will be published as soon as available for anyone interested in joining Al.

Here is the second part (Q8 – Q12) of Al’s China Futures Daily News website question and answers, with audio recording and transcript below.

Audio recording – Questions 8 to 12

Audio duration: 23min 24sec

Question #8: When traders have a profitable position, how does a trader keep a good mental attitude? Some traders are always eager to close a position to lock in the profits. How do you think about this? What mental attitude or technical techniques/skills do you have, when to close a profitable position with maximum profit?

Keeping good mental attitude

Going into any trade, I’m always thinking about whether I’m going to be taking a scalp or a swing profit. If I’m taking a scalp, it’s simple: I know what my profit target is going into the trade, and if it hits my target, I take my quick profit and exit. If I’m taking a swing trade, my intention is to hold on for a minimum profit of at least two times my actual risk.

I distinguish actual risk from initial risk because there’s a mathematical difference between the two. For example, if I’m buying and I put my stop below my signal bar, that is my initial risk. But if the market only pulls back 2 or 3 ticks after I enter the trade and then strongly rallies in my direction, my actual risk may have only been 3 or 4 ticks.

The mathematics of all trading is based upon actual risk. A trader should always go for a reward that is equal to at least two times his actual risk. However, that is the minimum goal. The minimum goal is rarely the best goal. In general, when I’m swing trading, I stay in the trade until the trade is no longer valid – for example, if there’s a signal in the opposite direction or I’m at the end of the trading session.

If a trade goes two, three, four times the actual risk, I usually take at least partial profits. A lot of beginners lose frequently. When they finally have a win, they’re so afraid of watching it turn into another loss, they take very quick profits. And that is unfortunate. If a trader has a low winning percentage, then he needs rewards that are much bigger than the risk.

If you think about the trader’s equation, it’s a balance between risk-reward and probability. If you lose most of the time, then your probability of success is small. The only way you can trade profitability then is if your reward is much bigger than your risk. You need a very high, a very strong risk-reward ratio. That means you need a very big reward.

I understand that if a trader loses most of the time, it’s natural to panic and be so happy at any small reward that you grab that reward. However, that is scalping. If you lose most of the time, you cannot scalp. A scalper needs a very high probability to be profitable. A good scalper is going to win 70%, 80%, or 90% of the trades. But remember, there’s a trade-off: the higher the probability of success, the worse the risk-reward ratio. In general, a good scalper is going to win 70%, 80%, or 90% of the time. However, his risk-reward ratio is lousy. His reward is usually very small and his risk is relatively big.

A beginner cannot win 80% or 90% of the time; therefore, a beginner cannot scalp. That means a beginner cannot take a small profit. If a beginner is going to be losing most of the time, he needs a very strong risk-reward ratio. That means he needs a very big profit. That means he has to stay in the trade until the premise of the trend is no longer valid.

For many traders, that is emotionally difficult to do. The key to success is trading the “I don’t care” size. That means you have to trade so small that you really do not care if you lose money. I understand the argument that if you trade so small that you do not care if you lose money, you’ll never get rich; however, you will get practice doing the right thing. Over time, you can then increase your position size, and at some point you might be surprised to find that you’re making an incredible amount of money.

Question #9: Is trend trading always effective anywhere? What will the technique analysis be in the future, in your opinion?

Trend trading

Markets are the same now as they were 100 years ago, 200 years ago. I’ve looked at a lot of charts from 100 years ago and longer, and if I remove the date at the bottom of the chart and the price scale at the right of the chart, I cannot tell whether the chart is a weekly chart from 1910 or a 5-minute chart from 2017.

Why is that? It’s because markets move based upon rational human behavior. Markets are controlled by genetics. As long as we are the same species, we will behave the same. Trading is just a reflection of rational human behavior.

Most of the American markets are dominated by computer algorithms, yet the markets trade the same as they did 20 years ago when there were no computers and 100 years ago when there were no computers.

Why is that? It’s because the computers are doing what is rational. Well, good traders have been doing what is rational for hundreds of years. The difference is computers just do these things faster. The result is they’re doing the same thing as excellent traders have been doing forever, and therefore the charts look the same.

The result is that trading will always be the same going forward. The computers will not change things. All they do is trade faster, and that makes a difference if you’re trying to make a trade that lasts 1000th of a second and trying to make one penny in a stock. However, that has no bearing on what I do. I do day trade and I sometimes hold a trade for as short as 10 or 20 seconds, but most of my trades are for 5 minutes to an hour. Those computers have no effect on what I am doing.

Question #10: Will you please forecast the macro situation of the investment market in the future? What’s your opinion about the trend of gold and oil?

Market and commodities forecast

I talk about this regularly in my chat room and on my website. It’s interesting. Let me just say one thing that you may not have considered. That is that if you look at any market – any market, even gold, crude oil – and you look at a chart that goes back 100 years, the price today is more expensive than it was 100 years ago. That’s especially true in the stock market. The price today is hundreds of times greater than it was 100 years ago, 150 years ago.

How can that be? A lot of traders believe trading is a zero sum game, that every dollar that I make is a dollar that somebody else loses. That is flawed logic. There’s a fundamental flaw to that. That might be true over the next 5 minutes or 10 minutes, but it’s not true over the next 5 years or 10 years. Look at the price of the Hang Seng index today versus 10 years ago or 20 years ago. Look at the price of the stock market today versus 10 years ago or 20 years ago.

For example, the S&P 500 today is about 2,000. Back in 2009, it was at 700. So right now it’s about three times greater than it was just 10 years ago, not even 10 years ago. Now why is that? It’s because the market is not a zero sum game.

The world is creating more wealth. So it’s not a zero sum game. There’s more money being made. There are more people in the world, and more people means more people earning money. The total GDP of the world is increasing. The productivity of all of the people in the world is increasing. Technology is allowing people to make more money per hour all over the planet. All of this means that the total wealth of the world is increasing. That means there are more dollars to buy stocks. It also means that people who are investing have more opportunity to make money.

Trading is not a zero sum game. The world is getting richer. As long as the population is increasing, you’re creating more producers, more people contributing to the gross national product of every country. Technology is also making people more productive.

The result is all markets are in a bull market over the course of years. No matter how bad the market is, how bad a bear market is, the market’s always going to be more expensive 5 years in the future, and that is because the total net worth of the world is increasing.

What do I think the stock market will do 10 years from now, 20 years from now? I think it’s going to be higher. Thirty years from now, it’s going to be higher. I’ve been trading for 30 years. I started trading back in 1987, and the market is much, much higher than it was back then. Back then I remember hearing a lot of people on television talking about how the stock market was going to go down to zero. It fell to about 200, and now it’s 2,000, so it’s 10 times richer than it was back then.

Do I think the stock market is going up in the future? Of course. What do I think is going to happen over the next few years? I think the United States bond market has put in the high for the next 20 years. I think the sell-off over the past year is overdone. I think the result is the bond market is going to rally over the next several months. However, I think it’s never going to go back to the price it was last year, and I think it’s going to continue to go down over the course of the next 20 years. Sideways to down for the next 20 years.

That means interest rates are going to rise. A lot of traders in the United States like to have some of their money in relatively safe investments. Traders have not been putting money in certificates of deposits (CDs) because the rate of return has been so small. If interest rates go up – which I believe they will – traders will discover that the rate of return from savings accounts and certificates of deposits (CDs) will be acceptable, and they’ll begin to transfer money from stocks into safe investments that have good returns.

As a result, as the bond market goes down and interest rates go up, the stock market will be pressured to go down. Therefore, what do I think is going to happen to the stock market over the next several years? I think the stock market can go a little higher, but I do not think it’s going to go a lot higher over the next several years.

I think the S&P 500, for example, had a huge buy climax over the past year. It’s at measured move targets based upon the monthly chart. So it might go up another 3% or 4% from here over the next year or so; however, I think it’s going to fall at least 10% or 15% over the next 2 or 3 years, and over the next 4 or 5 years I think it’s probably going to fall 30% or 40%.

That means that the upside over the next few years is small relative to the downside. So maybe over the next few years it’ll go up 3% or 4% or 5%, but I think it’s going to fall 10% within the next couple of years and probably 20% or 30% over the next 5 years. Yet, since it always has rallied 3 – 5 years after even the worst selloffs, it will be higher again 3 – 5 years after any selloff.

Talking about gold and crude oil, gold had a huge rally and a big, big buy climax that ended in 2011. It’s given back about half of that. Very often when there’s a huge buy climax like that, the market pulls back about 50% and then goes sideways for a long, long time. That’s what gold has been doing for the past 5 years. It’s now deciding whether it’s going to go back up to the 2011 highs or all the way down to the 2008 lows.

I think it’s slightly more likely that it’s going to go up than it is that it will go down, but there’s no compelling evidence that it’s going to go up anytime soon. It’s been in a trading range for 5 years. It could easily be in a trading range for another few years. Yes, it rallied strongly at the beginning of 2016, but only up to the top of the channel that began after the sell-off in 2013. To me it looks like it’s in the middle of a trading range, deciding whether it’s going to go back up to the 2011 highs or continue sideways indefinitely. To me there’s no compelling reason to buy gold right here, other than to trade the swings within the $400 range. Between 1,100 and 1,500 or so.

Crude oil? Crude oil has had two huge moves down from the highs in 2008. It sold off strongly into 2009, went sideways for about 6 years, and then had another leg down in 2014. The sell-off was climactic, and the market’s probably going to be sideways here. It might get back up to the $70 or $80 level at some point in the next few years, but I think there’s no evidence that it’s going to get back up to $100 anytime soon. It probably will have to go sideways for years – 2 years, 5 years, I don’t know. It probably needs several years of sideways move to build a base before it can get back up to that level, if it ever gets back up to that level.

Question #11: What do you think about the Chinese financial markets?

The Chinese financial markets

I frankly wish that I was living in China. I say that – obviously I’m very happy where I am, but from a trader’s perspective, I think the Chinese financial markets are excellent. The GDP is very high. I think it’s like 7% right now. It’s low for China over the past 10 years, but based upon American standards, a GDP of 7% is extremely high.

The result is a lot of things are going up. I don’t care if things go up or down because I can always sell and make money when they go down. However, I’m interested in big moves, and the Chinese market moves a lot – which is good for a trader. That’s pretty much the only difference between the Chinese market and the American market.

I’ve looked a lot at Chinese stocks in the Hang Seng index, especially on the 5-minute charts. If I remove the price and time scales on the charts, they look just like American markets. They’re very good trading markets. I wish the yuan was trading freely in the Forex markets because it probably would be the most popular market for Forex crosses. I think it would be fantastic to trade. I assume at some point it will be available, it will trade freely and traders will be able to trade it.

But for trading as a day trader, I think the Chinese markets are excellent, and if I was a young person living in China, I would be really excited about the prospects for making money as a trader.

Question #12: Can you please give some suggestions to traders who are looking for the trading way of themselves?

Finding your trading self

I think the most important suggestion is Laertes’ advice to Polonius in Hamlet: “To thine own self be true.”

I think it’s really important to develop confidence in your ability to analyze markets, and that takes a lot of time. You have to study charts a lot.

You also have to be very objective and humble. I think that is a really important quality that traders – that really good traders – have. I’ve received a lot of emails from students who have told me that they’re consistently making money, and what do they do to make more money? My answer is always the same: Stay humble. Don’t try to do more than what you’re doing. Just try to do better what you’re doing.

I think the most important thing for any trader to become profitable is to get rid of losses. Most traders starting out realize that, “Hey, I won over here, and then I won again over here, yet I lost over there and I lost on this other trade. I lost money.” If they look at their performance, what they’ll discover is they probably won enough to begin to make a really good living as a trader – if they could get rid of those losses.

I think that is really important: not taking bad trades, and if you’re in a trade that looks bad, getting out early. A lot of times traders will hold onto bad trades far too long, hoping that the market will turn around. A really good trader, when they make a mistake, they say, “Huh… I made a mistake. I’m wrong,” and they just take the loss.

That’s really, really important. Whenever your premise is not valid anymore, for whatever reason – if you took a trade and you decide that you made a mistake, or if you took a trade and the market quickly does the opposite – get out. Just get out. Whenever your premise is no longer valid, never hope.

People are naturally hopeful. I think that is an evolutionary thing. Thousands of years ago, if you’re trying to feed your family and you’re out looking to kill a deer for some meat and you don’t find anything and you just quit – you do that often enough, you and your family will starve, and your genes will disappear from the gene pool. However, if you’re always hopeful that you’re going to find a deer and you keep hunting until you get that deer, you and your family will have food and you will survive. Those hopeful genes will survive and get passed on to future generations.

There are all kinds of examples of that. Being hopeful is a quality that is genetically advantageous. However, it’s a big problem for traders because they often will take a trade, it goes against them, and they stay in the trade hoping that the trade will suddenly go their way and they’ll end up making money or avoid a loss. That’s a terrible problem for traders. Being hopeful is a very bad thing for traders. Being objective is very important.

I talked about the importance of trading the “I don’t care” size. That is just very, very true. You have to trade objectively, and the only way you can do that is if you really do not care if you lose money. That means that your losses have to be small. You have to trade small enough so that if you lose, you will not be upset, and when you have another signal you can go ahead and take that signal.

That’s why I think it’s very important to trade so small that you do not care if you lose. You need to stay objective. If you decide that your premise is no longer viable, you get out.

Another, I think, very important thing that traders have to do is develop confidence in their ability to make decisions. If some trader on television says that a stock is going up or that gold is going up and you have to buy, do not buy. The key to making money is a combination of an appropriate entry and management. That guy on television is not going to be there to help you manage the trade.

I already told you that 90% of the time, a trader can make money buying or selling if he manages the trade correctly. If some guy on television says to buy, that doesn’t tell you anything because you already know you can make money buying or selling at any time. The key is money management. That person on television is not telling you what to do tomorrow or next week or the week after. Unless you have that other information, you will lose money.

The key to trading is managing your trades appropriately. You have to learn to spot a reasonable setup. You then have to decide where your stop should be. You then have to plan on what is a reasonable profit target, and then you have to stay objective and you have to follow your rules. As long as your premise is still valid, you stay in your position. If the market does something that makes you think your premise is no longer valid, you have to get out. It sounds simple, and it is simple, but it’s difficult to do. And that is one of the keys to trading.

I got an email this past week that I get from traders every now and then. It goes something like this: “Al, thank you for teaching me how to trade. I now consistently make money. I no longer can remember why it was for years that I was losing money. I look at the charts and I don’t see how I can lose money. I cannot imagine what I was doing for all those years when I was losing money. Now when I trade, I only see profitable ways to trade.”

That’s really interesting. When a trader is starting out, first year or two or three, he’s losing money and he doesn’t understand how to get consistently profitable. After he’s traded consistently profitable for several years, it’s hard for him to imagine all the mistakes that he was making that prevented him from being profitable just a few years earlier.

That is, I think, the key turning point for every trader. You have to move into consistent profitability. It’s not a matter of getting lucky and it’s not a matter of suddenly getting one or two big trades. It’s a matter of consistently doing the right thing and consistently making good money, never worrying about making a huge amount of money.

When I’m trading, my 1st goal is never to make money. My 1st goal is always to do the right thing. To get into the trade, to get out of the trade, manage the trade correctly. That’s all I think about. Did I do what is right? Obviously, I want to make money, and obviously I want to make a lot of money, but I never think about that. All I think about is, “Am I doing what is right?” If my answer is yes, then I know I’ll make money, and I know I’ll make a lot of money.

I hope that you found this helpful. I’m Al Brooks. Thank you for listening.

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