Trading Essentials

The following articles, by Jake Bernstein, are filled with Jake's valuable insights and practical suggestions on how to be more successful in futures trading. New featured articles will periodically be added so bookmark this page and visit Jake Bernstein on Futures frequently!


Table of contents

The Essential Rules for Successful Futures Trading
- by Jake Bernstein

If you have even the most limited experience as a trader then you know that the system or method you use is only part of the overall formula for success. The fact is that lasting success as a trader depends on a combination of three primary ingredients. The essential elements for profitable trading are:

1. An Effective System
By this I mean a trading system or methodology which has a demonstrated history of success through all types of markets and which contains definitive, objective, operational rules.

2. Risk Management
I define this element of profitable trading as a method which takes you out of losing trades and keeps you in winning trades for as long as possible. Ordinarily this task is part of the trading system, however, traders often override their trading systems and, therefore, need a failsafe procedure.

3. Discipline
Under this element I include self control, persistence, positive attitude, and more. Last, but certainly not at all least:

4. Trader Psychology
By this I mean self-knowledge, and the ability to resist one's emotions even in the face of losses. I feel that if you can master or even come close to mastering all four, then you will achieve consistent success as a trader. Moreover, you will avoid the boom or bust syndrome which afflicts so many traders.

Whether you're a newcomer to futures trading or an old hand at this risky business, you are most likely one of the many individuals who would like to improve, who is motivated to improve, but who doesn't know how to begin the arduous task of changing your behaviors.


Here are some suggestions as to how you may embark on the road to lasting profits:

Examine your trading results by looking at your statements and attempting to determine why you made the trades you did. This will let you know at once whether your trades were at all systematic or if they were based on a whim, on emotion, on tips, rumors, fear, or greed.

If you're like most traders then you'll find that a relatively small percentage of your trades were the result of a system and that most of your trades were prompted by other factors, most of which were totally unrelated to any definitive system, method, or indicator. This will alert you to the first problem area in your trading. It will let you know, without a doubt, that you are not basing your decisions on a consistent approach.

What to do? Begin looking for a system which has simple, unambiguous rules of application. In finding a system consider the following aspects of paramount importance:

A. Simplicity
The rules must be simple to understand, simple to follow, and not subject to interpretation.

B. Historical accuracy
should be 55% or more. While it is entirely possible to profit using systems that have less than 40% accuracy, it makes things more difficult. So shoot for a higher percentage.

C. Longevity
Use a system that has been tested in various markets - bull, bear, sideways, choppy, etc. At least several hundred trades should be included in the test. The fewer the trades, the less likely the results are to be representative of reality.

d. Draw down
Find a system that has shown reasonable draw down. By this I mean no more than 35% from its equity peak. If you decide to select a system that has had more draw down, but which you like due to its accuracy and total net profits, then do not begin trading such a system until it has experienced a period of draw down.

e. Consecutive Losers
Most traders cannot accept more than 6 losers in a row. Many profitable systems have shown over 15 consecutive losers. Before you trade any system, know the historical facts. A high number of consecutive losers will cause you to abandon your discipline and the result will be a loss.

f. Study the worst case scenario
not the best case. System promoters naturally portray their systems at their best. In reality many systems deteriorate. Hence, you are far better off looking at a system in its worst light as opposed to its best light.

g. Make certain
that the profits of a system were not generated by one or two or three large trades. Such a system will be very difficult to trade. It will cause you to lose your discipline.

h. Risk management
is an important issue. Many a good trading system has been undone by faulty risk management.

i. Study the worst case scenario, not the best case.
System promoters naturally portray their systems at their best. In reality many systems deteriorate. Hence, you are far better off looking at a system in its worst light as opposed to its best light.

You can master the psychological end of trading by learning about yourself, or by using simple, time tested, mechanical techniques to overcome the problems. Purists would argue that such an approach is shallow and not conducive to long term change. I disagree. There are numerous mechanical techniques which can be used to overcome problems of trader discipline. Whether the application of these mechanical methods results in permanent changes is irrelevant. If mechanical methods work then use them.


What do I mean when I talk about "mechanical methods"?
Here are some examples:

a. If too many of your losses are the result of your not using stop losses, don't waste your time trying to figure out why you don't use stops, just have someone enter your stops for you. In fact, there are many traders who cannot follow their own systems. To overcome this limitation simply turn your system over to someone who will implement all of the trades for you.

b. How about a method for dealing with over-trading? The answer is simple. Most over-trading comes from either too much contact with the market or from attempting to trade too many systems. A mechanical way of dealing with this problem is to eliminate the source or sources of information that stimulate you to make too many trades.

c. Other problems can be solved by making a verbal contract with your broker. Consider the trader who enters stop losses but who changes them repeatedly as the market approaches the stop. In such cases the broker and client can agree that once a stop is entered it will not be changed unless the system so dictates.

Return to Table of contents



The Ultimate Factor Underlying Successful Trading
-by Jake Bernstein

While there are many things a trader can do wrong in the markets, there are only a few things he or she can do right. We are all well aware of how important risk management, discipline and a good trading system are, but without a doubt, they are all useless in the hands of a trader who is psychologically inept or self-destructive. It is unfortunate that traders still believe in the myth that a better system will make them better traders.

The ultimate factors in achieving trading success are primarily psychological or behavioral. My experiences have taught me that the following factors comprise perhaps 90% of the formula for achieving and maintaining market success:

1. Detachment
Many years ago I learned that in order to trade successfully you have to "not care" -- you need to be detached from your work as a trader. This is a lesson I learned early in my previous career as a clinical psychologist. While at first blush this may seem like a cold and unhuman way of being, it actually has many virtues under the proper circumstances.

Being human at times gets in the way of success by throwing emotional roadblocks in your path. Emotional roadblocks cloud judgment and inhibit success. Just as a surgeon must not become emotionally involved with a patient, a trader must not become emotionally involved with his or her trades, or, for that matter, with the idea of success. Keep yourself from caring too much and you'll have facilitated success.

2. Persistence
Clearly, the trader who is a quitter will never succeed since he or she will not be in the markets when the big moves occur. A truly great trader is willing to come back fighting after a loss or after a string of losses. A truly great trader will not take one failure, or for that matter a string of failures as a sign that it's time to give up, failure will, rather, inspire more effort and, ultimately more success. For those who have a copy of my book Market Masters, I suggest reading the Larry Williams chapter for a classical example of persistence and its resulting success.

3. Realistic Attitude
Finally, traders must maintain a realistic attitude in order to succeed in the game of high expectations. All too often traders have grossly unrealistic expectations about what they can achieve in the markets. Dreams of striking it rich, of finding the holy grail trading system, of being in on that one trade that makes you fabulously wealthy are self-destructive and divert your attention from the reality of your goal.

Those who promote the importance of having a positive attitude might take issue with my statement, yet I think that there's a distinct difference between having a positive attitude and having absurdly unrealistic expectations. One motivates, the other frustrates.

Many a trader has had dreams such as buying gold at $250 and selling it at $680. It's a great dream but it won't likely happen in this lifetime because there are few traders who can hold on to positions for such a long time. The fact of the matter is that you are far, far better off trading smaller moves which have a higher degree of accuracy than you are trading large moves which are not likely to occur and which, should they occur, will take so long to develop that you'll have at least 100 opportunities to make mistakes.

Should such moves interest you, trade them using the stock market or mutual funds as opposed to the futures markets, UNLESS you have totally mastered self discipline.

In Conclusion,
I feel that I have given you a thumbnail sketch of what I feel are the quintessential elements for success in the futures markets. While there are many offshoots of these simple but effective rules, the fact is that if you can grasp the general concepts and apply them consistently, you will fare well in the markets. When you eliminate all of the systems' sales hype, all of the glory, all of the frills, all of the technical jargon, all of the pretentious attitudes, all of the boasting and all of the idle promises - these facts remain:
Return to Table of contents



A Trader's Guide To Orders and Their Effective Use
-by Jake Bernstein

One of the most neglected, but most important areas in futures trading is ORDER PLACEMENT. Several times each week I get calls from subscribers with questions such as what do you mean on the hotline when you say MIT?, or what does STOP CLOSE ONLY mean? How you place orders and what types of orders you place can be very important. At times, they will spell the difference between a profit or a loss. What follows is a relatively brief discussion of the types of orders available to traders, and how to use them for best results.

Use a market order only when absolutely necessary. If you are using an intra-day oscillator type signal which enters at the end of a given time segment, then a market order is acceptable, perhaps even necessary. If, however, you can use a specific price order as opposed to a market order this is preferable. It is not uncommon for markets to make a quick move following a signal, but very often the market returns to its original entry price fairly soon, and a price order would have been sufficient. You can save a great deal of money this way.

If you're holding a large profit and wish to exit a position quickly once your indicators have turned, then it's worth giving some of the profit back just to make sure you are out of your position(s).

Avoid MOC (market on close) orders. All too often such orders are also a "license to steal" since they can be filled at almost any price during the last minute of trading. An MOC order in thin markets is a certain invitation to trouble. Avoid MOC orders unless absolutely necessary. They are not recommended. Many traders jokingly refer to MOC as "murder on close" orders since fills are often so poor. You may be better off simply placing a market order a few minutes prior to the end of the trading session.

Never use market orders with spreads. You are far better off using specific spread levels for entry and exit or you may use specific price orders in each market individually to "leg" into or out of the spread (i.e. enter or exit one side at a time). Considerable slippage is the rule in spread market orders. Unfortunately the only orders you can use in spreads are market orders or price orders. Of the two types, price orders are clearly preferable.

Market if Touched Orders (MIT)
An MIT order to buy is always placed below the market while an MIT order to sell is placed above the market. An MIT order becomes a market order when hit.Therefore, if you have an MIT order to buy at 4150, it will become a market order as soon as a trade occurs at 4150. The pit broker holding this order will immediately buy at the market. You could get filled at any price, but you will usually be filled at or near your order, at times better than your price and a times worse. An MIT order is used when you have a specific price level in mind for entry and you do not wish to take the chance of not being filled. Ordinarily such orders are used for selling at resistance above the market for buying at support below the market.

Traders who use some of the support and resistance methods described in this newsletter on many occasions, may use MIT orders, however do note that such orders can cost you a few ticks. MIT orders are not accepted by all exchanges, nor are they accepted at all times. Under certain market conditions MIT orders may be refused either at the discretion of the pit broker or the exchange.

Fill or Kill Orders (FOK)
A fill or kill order is entered at a specific price with the understanding that the pit broker will attempt to fill your order 3 times at the requested price. Hence, if you have an FOK order to sell at 4550, the pit broker who gets your order will offer it at 4550 three times. If there is no fill he will immediately cancel or "kill" your order and the "kill" will be reported to you very quickly. The advantage of this order is that you will be able to place it at a specific price and you will get prompt feedback as to whether it has been filled. And that's important! Be aware, however, that not all exchanges or brokers accept FOK orders. Under certain market conditions such orders may be refused. Some brokers will become irritated if you use too many FOK orders that go unfilled since it takes time and effort to place these orders. Discount brokers may be especially unhappy if you use too many FOK orders. Finally, do not place your orders too far from the market or they will not get filled. This will be even more aggravating for your broker. If you plan to use FOK orders then please use orders that are very close to the current price. If you abuse these orders you will frustrate your broker and you will lose the respect of the order takers. So please be mindful of the guidelines I have given you. FOK orders are useful in virtually all situations where entry at the market should be avoided but where there is a need to establish or liquidate a position. Remember that using an FOK order does not guarantee a price fill, it merely guarantees that you will be filled at your price or better or not at all.

Stop Orders
Stop orders are placed either above or below the market. A sell stop is placed below the market. A buy stop is placed about the market. These orders are especially good for exiting positions when they go against you or for entering markets on breakout's. The problem with stop orders is that you will not necessarily be filled at your price in a fast market. When sharp and sudden moves occur in the currencies, TBond futures or S&P futures the result is considerable price slippage. The best way to avoid this is to use a stop limit order as described below.

Stop Limit Orders
A stop limit order is a stop order with a price limit specifier. The reason for using such an order is to allow the pit broker more flexibility in obtaining a fill. Therefore, when you place a buy stop limit order at 6450 with a limit of 6465, this means that you will accept a fill within these limits inclusive. The good part of such an order is that it permits the floor broker more leeway in filling you and it therefore improves the odds that you will be filled. Such an order protects you from too much slippage. Stop limit orders should be used more often by traders, however, few traders actually use them.

Good Till Canceled Orders (GTC) - Open Order
A GTC order does exactly what its name suggests. It is an order which will remain in the market until canceled or filled. A GTC order is also called an OPEN ORDER. Typically all open orders are canceled by your broker at the end of each calendar month and must be reinstated. Position traders may use open orders frequently, while day-traders rarely need GTC or open orders since their work is done at the end of each day.

One Cancels the Other (OCO)
This is an order qualifier. It allows a trader to have two orders entered simultaneously with the cancellation of one contingent upon the fulfillment of the other. In other words, when one of the orders is filled the other will be canceled. This is a good way of "bracketing" markets for either of 2 possible outcomes. As in the case of several other orders noted previously, some exchanges do not accept such orders.
Return to Table of contents



The Do's and Don'ts of Order Placement
- by Jake Bernstein

Now that you've read about the different kinds of orders here are some suggestions regarding their use. The purpose of learning how to use price orders to your advantage is obvious. Profitable trading, but in particular, day-trading depends a great deal upon your ability to make every penny and every tick count. You must be consistent and frugal in everything you do. Here is a list of do's and don'ts with respect to orders:

Don't use market orders excessively.
Market orders cost you ticks. Don't use market orders in spreads. If you lose a few ticks getting in and a few ticks getting out then you have lost good money, often unnecessarily. There are many viable alternatives to market orders. Some of them have been discussed above, some will be discussed below.

Don't use MOC orders unless absolutely necessary.
They will cost you ticks. Ticks add up. A few ticks here, a few ticks there, pretty soon it adds up to real money. If you must use such an order then you are probably better off selling at the market several minutes before the close than in giving your broker an MOC order. As far as I'm concerned an MOC will, most often cost you a few ticks.

Do use stop limit orders instead of stop orders.
In many cases you will be filled. If you are concerned about not being filled, put a one or two tick limit on your order.

Do understand how Fill or Kill orders can be used to your advantage in several ways.
If you need to exit or enter a trade and you don't want to wait to find out if you've been filled then use a FOK order. You'll get quick feedback and you'll probably save money. If you've never used such orders before then get your feet wet before using them extensively.

Do use FOK orders to "test" a market.
One good way to see how strong or weak a market may be is to use an FOK order. Here's what I mean. Let's say that June S&P futures are trading between 406.50 and 406.90. You have a buy signal at 406.50. Trading volume is light. following the buy signal, prices move quickly to 406.90 and you don't want to chase the market. You are concerned that the signal might not work this time because the market fell back quickly to the original breakout price of 406.50. You are hesitant to buy. What to do? Test the market by placing a FOK order to go long at 406.45 or 406.40, knowing that this is below the recent range of trades. You enter your order and watch the tape. It reads 406.55 when you enter your order. The ticks then go as follows. ... 406.55... 406.50... 406.55... 406.50... 406.50... 406.45B (your bid)... 406.45. You are filled at your bid price. What does this mean about the character of the market? Most likely this indicates a market that is weak. You were filled at a low bid which means that there are willing sellers. This tends to characterize a weak market.

On the other hand, consider the same scenario with a different outcome. You enter your bid at 406.45 FOK. The tape reads 406.55 when you enter your order. The ticks then go as follows: 406.65..... 406.55.... 406.55.... 406.55... 406.60... 406.65... 406.65... 406.60... 406.65.... 406.60... 406.65..406.70... 406.65... 406.70... 406.75... etc. The market comes close to your bid but never hits it. The order is returned killed. What does this mean? It most likely indicates a market with good demand. It suggests that you had better get on board quickly. You may even want to use a market order to do so.

Do use MIT orders even though they are not always efficient.
They are good for trading within a support and resistance channel, however, they will cost you ticks. As a rule, I like MIT orders.

Do use OCO orders, where accepted; they are very helpful.
They will help you bracket the market with different strategies and should be used wherever needed.

Don't get confused about First Open Only.
Some New York markets have staggered openings (i.e. sugar). In these markets each contract month is opened individually in chronological order, traded for a few minutes, and then closed so that another month may be opened. Once the process has been completed all months are opened again at the same time. The same procedure is used for closing. Should you need to buy one of these markets on the open you are advised to specify that you want your order good for the first open only. All too often the second opening price is distinctly different from the first open. This can cost you money.

Do insist on prompt reporting back of order fills.
It is absolutely necessary for you to know when you've been filled and when you've not been filled. You must be strict with your broker in demanding fills back as soon as possible. Do not accept excuses, particularly in currencies, Tbonds, S&P, and petroleum futures where flash fills are easily given. A flash fill is one for which you may remain on hold as your order is hand signaled to the pit. While there will be some conditions in which delays are understandable, such delays are anathema, particularly to the day-trader, and must be avoided whenever and wherever possible.

Do know which exchanges will accept certain orders.
The rules change from time to time and from one market condition to another. If you don't know the rules, find them out. The Chicago Mercantile and IMM will accept almost all orders almost all the time. The Chicago Board of Trade is a stickler for accepting only certain types of orders. They do not accept MIT's. Some New York markets have restrictions as well.

Do find out how your broker places your orders.
Does he or she call the floor? Are your orders put on a wire for execution? Does your broker need to call someone who will call someone else who will then call someone else? This all takes time. Day-traders can't afford the time for such delays. Ask your broker for his or her procedures and deal only with those who can get you the fastest fills. Anything else will cost you money no matter how low the commission rate. Don't be penny wise and pound foolish.

Don't forget that Globex (24 hour) trading requires that you use even more discretion in order placement. Be very careful. Learn the rules and learn to deal with the lack of liquidity.

Do use price orders all the time when trading futures options.
A market order in options will frequently bring you shockingly bad results due to the poor liquidity. Always use price orders in futures options! Always!

Do learn how to place orders.
Make sure your terminology is correct, make certain you mean what you say, and make sure you listen to the order as it is repeated back to you. You are liable for your orders. Errors will cost you.

Don't beat around the bush when you place your orders. Speak quickly, decisively, and clearly.

Do keep a written record of your orders.
Even if you trade only one market, once a day, keep a written record which should include the market, whether you bought or sold, the type of order, the quantity, the price you were filled at and, your order number (as given to you by the order taker) and the time you placed the order. Don't fail to note all of the above. It will save you a great deal of money in the long run.

Don't delay in reporting all errors. The longer you wait to report an error, the great the less the odds of having it rectified.

Do always, always, always, always check out at the end of the day, especially if you have traded a great deal.
By "check out" I mean make certain you have received all of your fills and that you have closed out all of your trades. Many brokerage firms will send you a preliminary run at the end of the day via modem. Print out the run and check it against your order sheet. REPORT ALL ERRORS IMMEDIATELY!

CHECK YOUR ORDER SHEET BEFORE MARKET CLOSING
Make certain you have taken the necessary steps to close out positions. The more you trade and the larger your positions, the more important this will be.
Return to Table of contents


These are just a few suggestions which will, I feel, help you master the pragmatic end of day-trading. Don't ever discount the importance of proper order placement and consistent procedures. The wrong order in the wrong market can cost you plenty. I know. I've made all of these mistakes at one time or another, and I don't want you to have to repeat them. Learn it the easy way, from me! Don't learn it the hard way, by losing money.