Keith Law's Trading Plan

Keith Law's Trading Plan

Background

In 1994, I left a 31 year career with Telstra with a $94,000 redundancy payment and good accummulated superannuation. I knew nothing about finance and investment. What I quickly learned was that many financial advisors were really most interested in the commission they could earn. They wanted to put my funds into managed funds where they would receive upfront and trailling commission. After a short time of research I decided to rollover my superannuation into a conservative no fee fund and to manage my own non superannuation funds.

I had to acquire knowledge on how financial markets work and how to manage my money. I enrolled with the Securities Institute and after 4 years attained a Diploma in Financial Markets. In addition I joined the Australian Technical Analysts Association and attained it's Diploma in Technical Analysis. At the same time I began tentative trading in securities and read books on trading and technical analysis. I am convinced that this way of learning is much better and possibly less expensive than commercial trading guru courses.

The hardest part of trading is to learn the necessary self discipline. It is hard to acquire and lack of discipline is often expensive. The four signs of a lack of self discipline are

1. Guessing about market direction. You can not predict markets but you can react to market trands.You might guess right sometimes but it is still only a guess.

2. Lack of a Trading plan or Trading method.

3. Following tips and broker recommendations instead sticking with a trading plan.

4. Buying a stock because the price has fallen to a "cheap" level. This has cost me a lot of money as today's cheap is often tomorrow's expensive. When prices fall they often go much further than you expect.

It has taken me three or four years to acquire trading discipline and there are still times when I fall from grace and slip from the disciplined approach.

This document outlines my trading philosphy and method.

Trading or Investing?

The first decision is which general strategy to use. The options range from a long term buy and hold investment strategy to day trading. This time frame decision has to be made in terms expectations, available capital and effort required. The decision will relate to your over all financial plans, whether or not you have work income and commitments and your general attitude to risk.

I am carrying on a business of trading in shares, options and warrants. I have an Australian Business Number ABN and I am registered for GST. My main source of income is from trading activities while ad hoc opportunities to consult adjunct this income. The decision to manage income from trading as a business income rather than as investment income has significant taxation and accounting affects. My Gross income is defined as Sales less Cost of Goods Sold where where Cost of Goods Sold equal Opening Stock plus Aquisitions less Closing Stock. Business expenses are then deducted from Gross Income to give Net Business Income.

The main impacts of this decision are

1. All income is treated as normal income and capital gains concessions to not apply. This is not a problem as I rarely hold stocks for more than 12 months.

2. Business expenses are more readily identified.

3. Stock on hand at the end of the year can be valued at cost price or market price depending upon which method gives the best result. This allows a decision whether or not to bring unrealised profits or losses to account in any particular year. Losses can used to offset income without actually realising the loss.

Tools of Trade

I use the following tools because over time I have found they suit my skills. You must have a computer, some skill in windows and an office suite. You must have internet access.

Quicken Cashbook.

Essential tool for managing income and expenditure with excellent portfolio mangement tools. I have maintained detailed financial records since 1994 with all income and all expenditure recorded. This makes decision making and tax management simple.

Time & Chaos Personal Information Manager.

Calendar, Phonebook, Appointments and To Do lists. Much better than Microsoft Outlook and Lotus Organiser.

Commonwealth Securities

An inexpensive and comprehensive on line broking service. The web site is an excellent resource.

Fundamental or Technical Analysis?

I use technical analysis as my primary tool to decide when to enter and exit trades. However, I do not fully rely on technical analysis when deciding which stocks to trade. I closely monitor about 250 to 300 stocks although my data base covers all securities traded on the ASX. I do not include stocks onto my monitor list until I have considered the type and nature of the stock.

A knowledge of company fundamentals is useful in interpreting technical analysis charts and assessing risk levels.Companies with high price/earnings ratio, low or no dividends and potential rather than current earnings tend to be more volitile than low price/earning high dividend companies. This is obvious because the reason for investing in the two types of companies is different - one is the promise of high growth and possible future earnngs while the other relies on maintaining and slowly growing the earnings stream. This stock personality affects the way the stock reacts to stimuli and needs to be considered when analysing charts.

Before entering into a trade I examine the company fundamentals including current ASX announcements to ensure that there is no underlying weakness that will suppress the developing technical trends. I don't buy or sell on fundamentals or news but look at these as a way of classifying risk factors.

Omnitrader 2001 Release 2 (end of day stock edition )

I first used Stockeasy Analyst as my technical analysis tool. I then purchased Omnitrader directly from Nirvana Systems in the USA. Omnitrader is a sophisticated tool that may not be suitable for inexperienced software users. The program produces buy and sell recommendations according to complex rules that you can set. However, if anyone used the default values and tried to use the recommendations that result they would quickly have a disaster on their hands. It is a very good program but you must put a lot of work into understanding how it works and how to best use the substantial analytical ability in the program

With OmniTrader 2001, I get the following important advantages:

·  Automated application of trading systems to generate a consensus vote. OmniTrader has the ability to automatically run multiple systems and then "vote" the resulting signals so that those with more confirmation have a higher rating and precedence.

·  Filters and columns in the Focus List make it easy to isolate only the signals I want to be alerted to, such as all long signals, signals with Advisor Ratings above 60, and so on. This makes it even easier to isolate opportunities that have a higher probability of being those I would want to trade

·  The Focus List is a powerful data management tool consisting of the names of the securitiesI want to analyze and data about those securities.I can configure the Focus List to contain many pieces of information about a security or just a few.It has capacity to records notes against each symbol for future reference. It is also the place from which charts are selected for display.

Once it has finished analyzing the list of symbols, OmniTrader displays its buy/sell signals in the Focus List along with the signals and all the statistics behind the signals. By reviewing such statistics as Back Test Hit Rate (BTHR), Advisor Rating (Adv), and others, I can quickly isolate the candidates that warrant further consideration.

When a chart is activated OmniTrader will automatically plot ( as selected in chart options ) Trend Lines, Support & Resistance Levels, Fibonacci Retracements, Pivot Points, Candle Patterns, etc. Below each chart is the Vote Line showing the consensus signals for this security. Pull up the Vote Line and the Systems Area reveals all the trading systems that fired to form the signals on the Vote Line, with the best performing systems listed first. Click on any system line and a plot of the individual system is displayed, providing even more visual confirmation. Click on the signals on the Vote Line and the Advisor Dialog Box will appear, listing all the systems that fired to form that signal.

· 

Market Directions and Trends

My analysis starts with a top down view of market action. Each day I log onto the Comsec site to view the overnight US market performance and commentry. In addition Omnitrader provides a web based technical analysis of US markets - Dow, Nasdaq & S&P 100. These indicators will often give some guide to the likely action within the Australian Market.

In addition I use the Shareanalysis web site to check fundamentals on stocks within my watchlist. Automatic emails are generated each day with previous days closing price and highlighting any ASX announcements, profit warnings and valuation changes. Shareanalysis uses Discounted Cash Flows to measure the "worth" of stocks.

Within Omnitrader I monitor the main indices of the ASX and consider the technical siuation on these indices before moving down to individual stocks.

Omnitrader Preliminary Scan.

Each day a data base of all traded ASX securities is updated with the latest price action. Omnitrader then scans a profile of selected stocks ( about 300 stocks and a few selected warrants ) and analysis the 5 moving average crossover trading systems as well as the ADX and GAP systems. This produces tentative trade signals according to the specifications set up within Omnitrader ( these are variable and the values selected have significant impact of the Omnitrader results you achieve ). These specifications include defining a trading model, backtest and forward test periods with minimum hit rates and profit returns. These signals allow identification of stocks where a more thorough analysis of the data may be usefull. Omnitrader signals can only be considered as flags to draw attention to a possible setup.It is emphasised that a great deal of knowledge about the way Omnitrader processes information is needed to draw meaningful conclusions from Omnitrader trading signals.

Definitions

SMA Short term exponential moving averages 3,5,7,8,10 days

These lines are shown as white lines on Omnitrader graphs.

MMA Medium term exponential moving averages 35,40,45,50, days

These lines are shown as red lines on Omnitrader graphs.

LMA Long term exponential moving average 200 days

Shown as a red line on Omnitrader graphs.

Trading System

MV2-C Moving Average Crossover

Moving Averages have been used by technicians for many years. As markets advance, the "faster" or shorter-term moving average will rise above a longer term one, thus giving rise to a system that is in the market on the side of the faster average. There are two problems with this approach: (1) By definition, moving average systems generate late signals, and (2) many "whipsaw" trades are generated when a market consolidates sideways.

The Moving Average Crossover system generates good trades when a security begins a solid trend. However, since moving averages are late, whipsaws (and losses) will result in trading range markets.

There are 5 trading systems used to produce the multiple moving average analysis.

They are when the SMA cross the MMA or LMA. These crossovers are

3/35 5/40 8/45 10/50 and 7/200.

Omnitrader back tests each of these crossovers and produces trade results of that crossover system using the defined specifications for entry, exit and slippage. These moving average crossover systems are not optimised and are forced and show on all graphs.

Compacting Moving Averages

Reference pages 126 to 130 Trading Tactics Daryl Guppy

When the bands from the SMA and MMA begin to narrow down and converge prepare for price action. When each group of averages comes into price agreement and when both groups cross within a single narrow window of time, then the balance of probability is with a trend developing. Trade in the direction of the crossovers. Exit on downside crossovers. Medium term averages confirm the direction of the trend. The synergy displayed by looking at the inter relationship of the moving averages and the crossovers between these averages allows much better analysis than relying on a simple setup formula. The compacted averages tends to be a fulcrum upon which the price oscilates until a substantial movement occurs. A fulcrum is essentially a "line in the sand" in the battle between bulls and bears. These lines, identified by experience, are equilibrium points between buyers and sellers, and are usually found in the centers of consolidations (trading ranges). When price moves away from a fulcrum, it usually moves quickly and a great distance.

Supplementry Trading Systems

In addition to the moving average crossovers specified above, Omnitrader also calculates the ADX Breakout indicator and GAP Breakout indicator.

GAP-B Gap Breakout

Gaps have long been recognized as an important indication of new strength in a market relative to a given direction. A gap is defined as a "hole" in price action. If today's low is above yesterday's high, a gap-up has occurred equal to today's low minus yesterday's high. A gap-down occurs when today's high is below yesterday's low. Technicians use gaps in a number of ways but our gap system identifies gaps by generating signals in the direction of the gap.

ADX-B Average Directional Movement Breakout

Directional Movement is described by Welles Wilder in his book, New Concepts in Technical Trading Systems. The Average Directional Movement Index (ADX) is based on two oscillators, +DI and -DI. The +DI and -DI yield positive and negative directional values based on an accumulation of higher highs (+DI) or lower lows (-DI). ADX attempts to combine +DI and -DI into one number which defines an "average" direction for the market. According to Wilder, a trend is established when the ADX line exceeds |25| (the absolute value of 25, meaning that the trend can be up or down).

Exponential Moving Average

An exponential moving average places more weight on the most recent days of price activity, the theory being that the most recent days' activities has more bearing on a security's future price directions.