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The Art and Science: A Deeper Look (1/2)




Most losing traders lose because they do not truly understand the nature of the challenge before them. They do not understand the market, how it works, or the task of creating a profitable trading system. Sadly, much of the literature and many of the educational programs out there reinforce this problem, rather than making it better. How many times have you heard about “high probability trading” or listened to someone sing the praises of “high risk/reward ratio” trades? (They actually mean high reward/risk or low risk/reward trades, but I suppose that doesn’t make sexy marketing copy.) In reality, the task is to create a positive expectancy environment, which can be accomplished in many ways.  Essential to this understanding is a good grasp of random walks, and the problems a trader would face trying to profit in a random environment. The chapter moves on to cover some concrete ideas for investigating trading patterns, and ends with a look at the framework that sets the stage for everything that is to come: that all market action can be seen as the result of two forces. My theme here, and throughout the book is this: drive out error and imprecision in your thinking. Be precise in your understanding and thinking about concepts.


Traders are also remarkably imprecise in their use of charts. A chart is nothing more than a visual representation of market data, but there are good and bad ways to use them. This Chapter presents a very structured approach to understanding the market structure and the forces at work at any point. Also, the critical question of trader intuition is addressed up front and early, as many of the choices traders make in their development can help or hurt the development of intuition. (In the worst cases, traders can actually program faulty intuition, in which case they are probably doomed to failure.) The chapter ends with a look at what might seem to be an anachronistic and quaint suggestion: to maintain charts by hand. I know of no better technique to build a deep understanding of market patterns, but it requires real focus and dedication to get the maximum benefit.



Many books on technical analysis include sections on either Wyckoff or Dow Theory. I did not want to parrot what has been done before, or to trivialize the issues in market analysis, but the Wyckoff cycle is a good tool for understanding developing market structure. This chapter focuses on the psychological drivers of the standard four stage cycle, with a deeper look at the mechanics behind classical accumulation / distribution. It concludes with a system for classifying any technically motivated trade into one of four categories: trend continuation, trend termination, support / resistance holding or support / resistance breaking. That is all there is; every trade fits into one or more of those categories. Understanding this helps to put trades in the context of overall market structure, so we can move toward not trading patterns, but trading the underlying buying and selling conviction that sometimes creates these patterns.


Here’s where my study of classical trend structure departs from that in most books. This chapter features a very in-depth look at the issues and potential complications of trading trends, and at various ways to quantify the strength of trend. Though still from a high level structural perspective, these patterns are put in the context of real market action. Patterns associated with successful and failed pullbacks are examined in-depth, as are the pitfalls associated with standard tools such as indicators, trendlines, and levels. How many times have you heard someone say if a certain level is broken a trend will either begin or end? This is rarely true, and trades made around such naive approaches are probably not, on balance, profitable. This chapter explains why.


 Of the major market phases, trends are the easiest to understand the easiest to read because they are driven by real buying and selling imbalances. This chapter tackles the serious issues of trading in trading ranges and around support and resistance levels, and also puts these patterns into a multi-timeframe context.


As much as possible, I tried to avoid creating new jargon for this book, because I think that confuses and hides issues rather than clarifying. However, I made an exception here and used the term interfaces to describe the critical points where trends and trading ranges become “something else.” We investigate the transition from trading range to trend, which drives the classic breakout trade, and consider the patterns around both successful and failed breakouts. Next, a deep look at the ways trends end, with transitions from trend to trading range, from trend to opposite trend, and from trend to same trend (through a failed attempt at trend termination) are covered. Most traders learn to think about these issues when they suffer losses; this chapter forces the reader to think about them early on.



It would have been very easy to write a book on trading and market theory, but my main goal was to make a book that would be useful to practical traders. Presenting actual trading patterns is difficult, because the selection of patterns, the issues in managing them, and the timeframes involved is largely a matter of personal preference. In the end, I chose to put all my cards on the table, and essentially laid out all of the patterns I find useful in actual trading. This chapter shows each of them from setup, entry, initial stop placement, and the perspective of active trade management.


I can pretty much guarantee you’ve never seen anything like this chapter in print. It features an exhaustive look at several indicators, working from the approach of feeding them simplified data sets to see how they react to inflections in real market data. Do you know how your favorite indicator reacts to large spikes, slow accelerations, or long flat periods in the market? Do you understand how the behavior of different types of moving averages is different? This is an extension of my admonition to think precisely and to truly understand the tools you are using. This chapter also takes a look at tools and issues in trading relative value plays, and ends with an explanation of why volume does not feature prominently in any of my work.


 Successful trading goes far beyond simply having patterns for entry. We all know this, but many of the issues related to trade management are not adequately examined in the literature. This Chapter takes a deep look at the impact decisions have on developing trades. What is the effect of taking partial profits vs. partial losses? Where do you add to trades? How do you tighten stops? Do you ever widen stops? Issues like initial stop placement, price targets, and how positions move together are also considered. The Chapter ends with a look at some practical tools you can create for monitoring your positions, and some tips on executing large orders that will be relevant as your trading size grows. These trade management tools and concepts are far more important than entry techniques for your ultimate success as a trader.


In some sense, the job of a trader really can be reduced to risk management. This chapter takes a look at many of the ideas behind tactically managing risk, starting with the critical issue of position sizing moving to the impact of changing risk on various trades. (Not surprisingly, the correct answer is to be consistent.) Next, the Chapter moves into some theoretical perspectives on risk that will be familiar to portfolio managers, as well as some simple tools to quantify risk. The Chapter ends with the challenging proposition that most traders struggle because they do not understand the true nature of risk.


This Chapter includes approximately 30 trade examples, most illustrated with a before and after chart, of the patterns in Chapter 7. Most of these examples were trades I actually made while writing the book, or published in my daily research report. (Originally, I had intended to limit this Chapter to only trades I actually executed, but there were several good examples I missed in real trading. I thought the pedagogical value of the examples outweighed my desire to only print actual trades.) There are many, many examples of pattern failures and discussion of the decisions that might have been made at various points in the trade’s life cycle. A trade is a process, not an event: from context to entry trigger to trade management, every part of the process must be mastered.

 I will followup soon with a look at the last two parts of the book.


Adam Grimes has over two decades of experience in the industry as a trader, analyst and system developer. The author of a best-selling trading book, he has traded for his own account, for a top prop firm, and spent several years at the New York Mercantile Exchange. He focuses on the intersection of quantitative analysis and discretionary trading, and has a talent for teaching and helping traders find their own way in the market.

This Post Has 7 Comments

  1. txchick57

    Concur on the value of charting by hand on graph paper. I did that for years before the internet. Although you aren’t talking about day trading so tape reading is not relevant, learning that via actually watching ticker tape and keeping track of where most of the trades took place was also valuable.

  2. H.H.

    Really looking forward to this book. Depressing that it will not be out for another 6 months or so.

  3. software

    Great episode Adam. I’m really impressed to read this series about the Art and Science. The entire article is very complicated learning. Thanks!

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