Monday, August 26, 2013

Yu, Way of the Trade

High frequency traders are a fact of life in the markets. They justify their activity by claiming that they provide liquidity. But, Jea Yu argues in Way of the Trade: Tactical Applications of Underground Trading Methods for Traders and Investors (Bloomberg/Wiley, 2013), the algos/HFTs generate volume and magnify momentum “by luring in and trapping the greatest number of participants on the WRONG side of the trade so they can kidnap all the liquidity and ransom it out to the highest bidders. … They don’t steal liquidity, just as kidnappers don’t steal their victims. They just borrow long enough to extort the highest prices for the return.” (p. 15)

Whatever we might think of high frequency traders (and the debate rages on), retail traders simply don’t have the firepower to compete directly with them. They need new tools to navigate a treacherous landscape.

Jea Yu, cofounder of UnderGround and the author of three earlier books, introduces the reader to the ideal trader for these conditions: the hybrid market predator who has “the precision timing of execution, risk averse scaling, and technical analysis of the daytrader, the premeditative assertiveness tethered by patience and risk management of the swing trader, and the relentless investigative fundamental prowess of the investor. Whereas all three roles have butted heads in the past, now they are components that converge to manifest into a more efficient market predator that can seamlessly shift between skillsets to adapt to changing landscapes, climate, and terrain.” (p. 43) Of course, as we know, easier said than done.

The ideal trader seeks to exploit pockets (think football). “The caliber of a trader … can be gauged on how efficiently he can spot, time, and work the pockets in the market. The pockets that pertain to execution are transparency, liquidity, and momentum. The pockets that pertain to conditions are divergence, reversion, and convergence. These pockets construct the elusive window of opportunity.” (p. 48)

In this book Yu offers both general guidelines and specific trading strategies, complete with color charts. Among the general guidelines, he describes the eight-step process required to turn an idea into profit: (1) constantly monitor the macro market conditions, (2) filter/qualify to determine if the idea presents a viable opportunity, (3) analyze the risk/reward, support/resistance, (4) devise a trading/strategy plan with triggers/scaling points/stops/set-ups, (5) factor in the macro market context—convergence/divergence/fades, (6) execute the trade and manage risk (size + set-up + duration), (7) manage the trade by monitoring the technical with macro market, and finally (8) exit the trade—scale out position/down exposure into liquidity pockets.

He describes in detail “the strongest price pattern” he has ever played—what he calls the perfect storm pattern trade. “Simply put, this powerful pattern forms when three or more pups/mini pups (or inverse pups/mini inverse pups) form and converge simultaneously on three or more separate time-frame charts (of the seven total time frames).” (p. 157) I’m not going to explain this pattern—or for that matter the meaning of “pups”—here; Yu himself spends almost fifty pages on it.

Anyone who opens this book thinking that trading is easy and that the market simply hands over profits for the asking (the “15 minutes a day for 50% annual returns” crowd) will be in for a rude awakening. For those who are serious about making money in the markets, however, Yu opens windows himself. There’s something for traders at every level in this book. It even takes a stab at options trading. And for those who are happier with streaming video, each copy of the book comes with its unique access code to a 70- or 90-minute (depending on which description you believe) video course.

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