Saturday, October 17, 2009

Proactive and Reactive Trading

When trading ranges are restricted, the amount that intraday traders can take out of any given market move will be limited. This makes execution--the ability to obtain good prices that maximize reward relative to risk--particularly important in choppy market conditions.

I define reactive trading as trading that is impulsive, often initiated by a fear of missing a move that seems to be getting under way. Instead of being guided by a forward sense for where the market is likely to go, the trader jumps aboard moves that look like they're going. More often than not, those moves reverse, leaving the trade underwater and the trader frustrated.

This is one reason why I like to start trades with profit targets, not entry setups. You enter a business venture only if you see significant profit potential: if the big picture isn't right for an entrepreneur, the venture isn't worth pursuing. Each trade is a business venture in miniature: it begins with a recognition of meaningful potential for gain. Only then does the entrepreneur/trader figure out how to pursue the venture so as to limit overhead and maximize profit.

In a range market, and especially in slow market conditions, it is necessary to temper one's expectations. Early in the morning when in a range, I'm looking to see if we are more likely to take out the overnight high or low; yesterday's high or low; the R1 or S1 level; etc. Incoming relative volume helps us understand how much participation there is in the market, which will provide useful guidance for how far we're likely to move.

Measures of intraday sentiment, such as NYSE TICK and the Cumulative Market Delta, will give us important guidance as to the likely directionality of movement.

Together with profit targets, our estimates of volatility and directionality help us frame proactive trades in which we wait for pullbacks from the expected direction of movement to enter anticipated moves to our targets. By defining price and/or indicator levels where our trade idea is clearly wrong and sizing the initial entry with a fraction of one's total buying power, we both define and control risk, even as we pursue profit with an entrepreneurial spirit.

Discretionary trading need not be reactive trading. A good entrepreneur passes up many business ideas before setting forth with a specific venture. So it should be with trading. If you're a developing trader, the links in this article will help get you started.


My Trading Edge said...

Hi Brett,

Thank you for this post. I sought external assistance in order to develop a strategy to overcome this problem. I outline it in the following

jamesk said...

Thanks Dr. Brett. I agree 100% with your post, although I like to say that by being PROACTIVE with one's planning and homework, one can then be decisively REACTIVE to one's system based trading opportunities, which sometimes are only available momentarily. They key is distinction is to react based on a plan rather than on emotion.

E said...

JK is a valued member of our community. This is an oustanding comment he made in our members area today that I felt was worth sharing. (Sanitized)

Another great post from Dr. Brett on Proactive vs Reactive Trading. Very consistent with our approach. “Scalps only”, “xxxxxx thinking”, “Trailer only”, “BO + xxx″.

So we absolutely think in terms of profit targets for our trades, only we define them in term of numbers of points available.

Also, since we are generally outside in, rather than breakout traders, we generally avoid the mistakes of getting caught going the wrong way when trading the system.

We are fans of being REACTIVE, but we need to think of it in a different sense: We ANTICIPATE where the market is going and REACT when it gets into that area. Notice, for instance that the market may only spend a moment in a particular target area, such as the overnight 95 or Thursday’s late 91 and 93. One needs to have done the necessary preparation and homework as we do every day such that he can quickly and decisively act on an entry or exit signal rather than later being stuck reacting based on emotional signals"

Our Philosophy is PPTPAR:
Price, pattern, Timing, Psychology, Anticipate, React


JamesK is too modest to say that he nailed that trade.

He was ready, and was willing to take the risk.

Isn't that what trading is all about?

Thanks JK for passing this post on to us, and thanks to Dr. Brett.

JimRI said...

Dr. Brett,

Your posts are excellent and this one like many others are point on with what I am personally struggling with. I find that in reacting to a confirmation of a move, I am then too late and simply giving my money to those who were ahead of me. But on the other hand in acting to proactively anticipate a move I am often just not right. In fact wrong more than 50% of the time which would be random. This I think is becuase my prejudices about direction are influencing my decision. I see the medicine for this as better information and better recognition of setups that the information discloses to me.