Edition 289 Wednesday, March 10, 2010 |
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Commentary by Andy Jordan
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On February 7 we told subscribers of our professional daily spreads & position/swing trading newsletter Traders Notebook, "Consider entering a soybean complex equity spread: long May Soybeans and short May Soybean Meal (50*SK0 – 100*SMK0) at a close above $20,050. Suggested risk is $1,000. Initial projected objective is $1,000 then higher. Basis is seasonal (2/2- 3/3) and a 1-2-3- low."
Here's how we suggested managing this trade:
02/08 Suggest entering the spread at $20,300 or better.
02/09 In at approx. $20,300. Suggest exiting on a close below $19,300.
02/17 Suggest exiting on a close below $20,100.
02/17 Suggest exiting on a close below $20,100. Suggest cashing in the first lot on the next up move.
02/23 It was possible to cash in the first lot at approx. $20,900.
02/25 Suggest exiting on a close below $20,550.
03/02 Suggest exiting on a close below $20,700.
03/03 Suggest exiting on a close below $20,850.
03/04 Suggest exiting on a close below $21,000.
03/05 Suggest exiting on a close below $21,100.
Visit our Spread Website for more information about our daily newsletter, Traders Notebook.
The Law of Large Numbers
(Some basic mathematics stuff a trader should know – but don’t get discouraged if the first part of this lesson seems very complicated. It all becomes crystal clear later on.)
The law of large numbers (LLN) is a theorem in probability that describes the long-term stability of the mean of a random variable. Given a random variable with a finite expected value, if its values are repeatedly sampled, as the number of these observations increases, their mean will tend to approach and stay close to the expected value.
The LLN can easily be illustrated using the rolls of a die. That is, outcomes of a multinomial distribution in which the numbers 1, 2, 3, 4, 5, and 6 are equally likely to be chosen. The population mean (or "expected value") of the outcomes is:
(1 + 2 + 3 + 4 + 5 + 6) / 6 = 3.5.
The graph below plots the results of an experiment of rolls of a die. In this experiment we see that the average of die rolls deviates wildly at first. As predicted by LLN, the average stabilizes around the expected value of 3.5 as the number of observations becomes larger.
The LLN is important because it "guarantees" stable long-term results for random events. For example, while a casino may lose money in a single spin of the American roulette wheel, it will almost certainly gain very close to 5.3% of all gambled money over thousands of spins. Any winning streak by a player will eventually be overcome by the parameters of the game. It is important to remember that the LLN applies only (as the name indicates) when a large number of observations are considered. There is no principle that a small number of observations will converge to the expected value, or that a streak of one value will immediately be "balanced" by the others.
So, why is this important for a trader?
It is important to understand that we all trade based on probabilities. All we really know is that we can make money with trading only in the long run. We have no idea of what will happen with our next trade, or with the next ten trades!
Let’s have a look at the following chart.
The 5 equity curves from above are based on a trading method with the following statistical values:
Winning Percentage is 20%, and the winners are 5 times bigger then the losers.
As we can see on the chart above, all equity curves are showing a profit in the long run. But we would have to go through different emotional periods while trading on the same probabilities. The trader trading the red line would get mad right in the beginning. He would start losing in the beginning, but do well later. The green trader would get even more frustrated. After trading for almost nothing for the first half, the equity goes down a lot before moving up nicely at end of the year.
As you can see, both would end the year with almost the same result. But the way they got there was completely different.
Once again, all curves above are based and calculated at random using the same parameters.
What does this mean for us?
This means we have to make sure we stay in the water long enough for the big wave to take us into the profit zone. We have no idea when this will happen, at the beginning of the year or at the end.
Here is what we have to do:
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The Spread Scan weekly newsletter is designed to assist you in becoming a better, more complete trader by showing you, within the context of the markets, how to trade spreads.
In this newsletter you will see applications of spreading in the futures and commodity markets. Spreads are applicable to all futures markets including currencies, commodities, financial instruments, and stock indexes. It is even possible to trade spreads in the all-electronic intraday market using day trading techniques.
Spreads are based on seasonality, correlation, backwardation, chart patterns, and simple observation. Spreads follow the Law of Charts™ and can be implemented using the Traders Trick™ entry.
In each issue of Spread Scan, you will find an upcoming spread trade for your consideration in the following week. You will also find a review of an existing or closed spread so you can see and learn how spread trades are managed.
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Educator for Spread & Swing Trading and Editor of Traders Notebook & Spread Scan
Andy Jordan made his first option trade at the age of 18. Since then he has been fascinated by the world of trading. In 2002 he met Joe Ross, and became interested in spread trading. Andy was then intensively tutored by Joe Ross and personnel at Trading Educators. Andy is the founder and president of Jordan Trading, S. A. Even though Andy has shown through live chats and in several trading journals that he is able to day trade today's markets, spread trading has always been his preference. In addition to his own spread trading activities, Andy is the editor of Traders Notebook. For those interested in one-on-one personal coaching, Andy has developed and instructs an online course in spread trading, "Trading Mentoring - Trade with a Pro," during which he demonstrates all aspects of trading from choosing the trades on through how and when to enter the trades, manage the trades, and exit the trades.
Andy Jordan was born 1965 in Germany, but is currently living in the Caribbean. He has studied mathematics and business administration in Regensburg and Hagen, and holds a PhD in mathematics.
Joe Ross has been trading and investing since his first trade at the age of 14, and is a well known Master Trader and Investor. He has survived all the up and downs of the markets because of his adaptable trading style, using a low-risk approach that produces consistent profits.
Joe Ross is the discoverer of the Ross hook™, and has set new standards for low-risk trading with his concepts of "The Law of Charts™ " and the "Traders Trick Entry™." Joe was a private trader and investor for much of his life, but a serious health situation in the late 80's caused him to shift his focus, and that is when he decided to share his knowledge. After his recovery, he founded Trading Educators in 1988, to teach aspiring traders how to make profits using his trading approach.
Joe Ross has written twelve major books and countless articles and essays about trading. All his books have become classics, and have been translated into various languages. His students from around the world number in the thousands. His file of letters containing thanks and appreciation from students on every continent (now including Antarctica!) is huge. As one tutoring student, a successful trader, wrote: "You have no idea how much improvement in my life and in my trading efforts have those three days with you brought to me."
Joe Ross holds a Bachelor of Science degree in Business Administration from the University of California at Los Angeles. He did his Masters work in Computer Sciences at the George Washington University extension in Norfolk, Virginia. He is listed in "Who's Who in America." After 5 decades of trading and investing, Joe Ross still tutors, teaches, writes, and trades regularly. Joe is an active and integral part of Trading Educators. He is the primary author and Editor-in-Chief of the company's newsletters: Chart Scan™, Spread Scan™, and Traders Notebook™. He is also the editor of the Traders Money Club™ and the host of the free Traders Live Chat, the free European Chat for Traders, and the moderator of his popular trading forum.
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