Entry —The point at which the trader initiates a long or short trade or a portion of that trade. An entry can occur “at market,” which means the trader is willing to accept whatever price is currently available. Or, the trader can use a “limit order,” which defines a specific entry price.
Context: Jane is checking the charts to find a good entry point for ABC.
Stop Loss– The predetermined point at which a trader accepts a loss and exits a trade. By placing a stop, the trader attempts to define his or her risk. By accepting a small loss, the trader eliminates the possibility of a large loss.
Context: Jane placed her stop just beneath ABC's recent low point. If ABC reaches a new low, she'll automatically exit the trade.
Target– The predetermined point at which a trader intends to take a profit. By using a target, a trader defines the trade's potential reward. Some traders prefer to use multiple targets as a means to stay in winning positions longer.
Context: John closed half of his position at his first target and hopes to close the other half at the second target.
Time Horizon– This refers to the length of time that the trader plans to remain in the trade. A “day trader,” someone who enters and exits a trading position on the same day, has a very short time horizon, while a mutual fund might have a time horizon that is measured in years.
One trader may operate within multiple time horizons, but it's important to remain consistent once the trade has been entered. It's usually a bad idea to turn a short-term trade into a long-term position just because the trade isn't working out as planned. Yet if we look into the account of an average investor, we might find unprofitable long-term positions that started out as short-term trades.
Context: John is an extremely impatient trader; he has the time horizon of a fruit fly.
Time Frame– This term refers to the length of time measured by each point, bar, or candle on a chart. Commonly used time frames include the weekly, daily, 240-minute, 60-minute, 30-minute, 15-minute, 5-minute, and 1-minute charts.
Context: For her time frame, Jane analyzes the overall situation on the daily chart before searching for trade setups on the hourly chart.
Bulls and Bears —The terms “bull” and “bear” appear frequently in trading literature, but what is the origin and significance of those terms? An upward movement is considered bullish because the attack of a bull occurs in an upward motion. An attacking bull lowers its horns and then thrusts them sharply upward.
Context: U.S. Dollar bulls pushed the currency to a new six-month high today.
Conversely, an attacking bear swats downward with its paws, which is why a downward move in the market is referred to as bearish. Images of these two beasts engaged in battle with one another, with the bull thrusting its horns higher while the bear swats downward from above, hang in the offices of brokers and traders around the world.
Context: The huge rally in metals prices has gold bears on the run.
Trend —A “trend” is a directional bias in price movement. Trends are important because they give traders an edge; if the price is moving persistently higher or lower, traders will attempt to exploit this movement by taking trades that favor the direction of the trend. The concept of trend trading is used as the basis of many popular trading strategies.
In technical analysis, an “uptrend” is represented by a series of higher low prices and higher high prices. Conversely, a “downtrend” can be accurately described as a series of lower high prices and lower low prices. Trends can remain in effect for months or years. Almost all trends end eventually, but attempting to guess when a trend will terminate can lead to hazardous trades and disappointing results.
Context: Jane established a long position in ABC because of the stock's strong upward trend.
In Figure 2.1, we see a sustained uptrend on the daily chart of the U.S. dollar/Japanese yen currency pair (USDJPY) that formed in the early part of 2013. This is an upward trend because it consists of a series of higher high points (HH) and higher low points (HL).
Figure 2.1 A Series of Higher Highs and Higher Lows in USDJPY
Similarly, a downtrend consists of series of lower highs and lower lows. This concept is demonstrated in Figure 2.2, which shows shares of Herbalife Ltd. (HLF) forming a series of lower highs (LH) and lower lows (LL) starting in early 2014. Trends can occur in any time frame, and are not limited to long-term charts.
Figure 2.2 A Series of Lower Highs and Lower Lows in Shares of Herbalife (HLF)
Context: When John noticed the prolonged downtrend, he knew he wanted to open a short position.
Fade: When a trader takes a position in opposition to a stock's movement, he or she is said to be “fading” that move. Possible reasons for fading a move include the following: The trader is expressing a lack of faith in the move; or believes that the market has misinterpreted a news item; or believes that the market has moved too far, too fast, and that the price is likely to return to a previous level. This term can be applied to a bullish or a bearish move.
Context: John felt the market overreacted to the strong employment report, so he faded the rally in the S&P 500 futures.
The more you use the terminology, the more comfortable – to the point of becoming second nature – it becomes. Most importantly, it leaves no questions about what you are doing and where you stand with your trades.
Trading terminology is indeed a language unto itself. The ability to understand and apply that language is critical when communicating with banks, brokers, and other market participants. In many cases, the lingo used by traders allows them to describe a situation with precision and effectiveness. It is also a means by which a trader can identify other traders.
CHAPTER 3
The Cornerstone
The concept of making money by trading the markets – not from producing goods or transporting them, but by trading shares of the companies that do so – has been around for centuries. The idea of striking it rich, or of improving one's standing in the world by the sheer force of one's intellect, is an intoxicating concept that has mass appeal.
Trading markets have often been maligned as being unfair and tilted against the “little guy,” and with good reason. There are many examples of disparity in the trading markets, such as:
• The use of non-public inside information by unscrupulous individuals and companies
• The pump and dump antics of certain brokers, particularly involving penny stocks
• Analysts that tout a company to drive up its price, in order to allow their employers to sell at more favorable levels
• The use of high-frequency trading robots, which can place and cancel hundreds of thousands of orders in a millisecond
Despite these hurdles, trading is still a meritocracy in many ways. The markets do not care about your age, your skin color, or your beliefs. Markets do not care where you grew up, who your parents are, or where you went to school. The only thing that matters is the ability to extract money from the market. If you can do that on a consistent basis, you can change your life and the lives of the people who matter most to you.
Because of this strong appeal, men and women have been vying for centuries to create systems and techniques designed to anticipate market moves. This has led to a variety of concepts,