Trading Reversals and Pullbacks

TraderInterviews.com: Hello everybody! Thanks for joining me for another episode this week at TraderInterviews.com. Our guest today is going to be TJ Noonan. He is a trader. We are going to talk to about his strategies and his philosophy of approaching the market and maybe get from him some ideas about how he finds opportunities in the market each day. So, TJ, thanks very much for joining us on the show today.

TJ: Oh, it's my pleasure to be here Tim.

TraderInterviews.com: Well, I usually start with background. Tell me how you got started trading?

TJ: OK. Well, it's an interesting story but I'll try to keep it brief. Back in the early 90s, I was introduced to trading. I think I just received something in the mail and it just struck as being kind of intriguing and seemed really easy and a great way to make some money, and boy was I mistaken! But that kind of hooked me in and it's been quite a journey ever since.

TraderInterviews.com: Well, so what markets are you primarily trading these days?

TJ: These days I primarily focus on E-mini futures.

TraderInterviews.com: That seems to be the popular one; the S&P E-mini contract is that what you're trading?

TJ: Actually no. I pretty much stay away from the S&P these days. I believe there are better and easier markets to trade. The S&P, I think, has some unusual challenges that I don't feel I should have to put up with, so I pretty much have been trading the Russell E-mini, trade the NASDAQ and the Dow E-mini.

TraderInterviews.com: OK. All right. So, a little bit different than a lot of traders these days. What made you pick those markets as the E-minis to trade?

TJ: Well, I have different reasons for each of them. The Russell, as you know, it's moved recently from the CME over to the ICE exchange and I think that after a few months that it's been on the ICE, it has just been trading fantastically. There's really good range and movement and it just works well with the strategy that I use, so I typically am able to meet my goals on most sessions. And with the NQ, the NASDAQ E-mini, that also moves very well and it's a great market to trade, you could put on a very small risk for trade and hit a good winning percentage and steadily grow your account and it kind of fits good within my overall trading philosophy.

TraderInterviews.com: So, how many of each of these different markets or E-mini contracts, how many are you trading each day?

TJ: You know I'm pretty much keeping my trade to 2% risk versus my trade account size. So, you know, that could fluctuate up and down but that's going to dictate the amount of contracts that I'm going to put on in general and that again also plays into my approach and my overall trade plan.

TraderInterviews.com: OK, we'll talk about that overall trade plan. When you say that, what does it entail?

TJ: Well, it begins with research in order to... the way I chose the Russell and the NASDAQ and even the Dow began with doing a lot of manual back-testing, and basically going back and looking at a time frame where I can, you know, quickly and visually see there would be enough trades in a particular session and if those trades were large enough to make it worth my time but not too large where I'd have to put on too much risk or spend too much time in front of the computer. And I was able to pretty much find the sweet spot as it fits within my own personal goals and lifestyle. I don't want to trade all day everyday. I want to get in there, get my work done, hit my goals, and be finished and then go off and do the rest of my life each day, which is filled with all kinds of activity. So, with that in mind, I approach my back-testing and once I establish that I had enough trades and a good result, in other words maybe after a couple hundred trades I can see that I'm winning, you know, 60+ percent of the time and then I could see and relate the losses to the winners and the worst losing streaks and the winning streaks that ultimately come after, and then basically the equity growing and growing, then I would go and practice trade it for a while and make sure that I can execute it properly and if I can do 25 consecutive live sim trades in a row without making a mistake. At that point, I'm ready to take a life. And that's pretty much how I've approached those markets that I'm trading right now.

TraderInterviews.com: All right. So, if you're testing a strategy then you're saying... when you say don't make a mistake, does that mean you want to see 25 non-losing or winning trades in a row?

TJ: No, not at all. What I want to be able to do is trade my trade system to it perfectly. In other words, I want to execute the trades properly. I don't want to hit buy when I meant it sell; I don't want to hit the number 6 when I meant to hit the number 9, that sort of thing. I also don't want to be second guessing. I don't want to talk myself out of a trade if my system says that that's an entry. I want to be able to react to it and get my order in without feeling insecure, without trying to second guess. It might mean adjusting around key levels, making minor adjustments to my entry price or my stop, that sort of thing; all as it relates to the rules that I've already set forth. So, that's what I mean by mistake-free trades. Losing trades are part of trading; you cannot in my view separate losing trades from the winners. And if you try to do that you're going to end up getting the losses and missing the winners, and I could get into the reason why I think that's true, but --

TraderInterviews.com: Sure.

TJ: Well, first of all, I think that trading is a very non-human activity. It's very counter-intuitive. And if you're a human being, while you're trading, you're probably going to fail. You really have to step out of yourself and be objective and that's why a good trading system is so important because the trading system itself keeps you objective. Now, the thing is, is that if you don't go through the necessary foundational work to take internal ownership of that trade system, you're not going to be able to trade it accurately, you're going to make mistakes, you're going to second guess, you're going to feel uncomfortable, you're not going to have the confidence to trade it and believe in it. And the only way you're going to really make money is by the edge that that system gives you over time. And so, that's hard to do! Because imagine if you've taken three losses in a row, it's kind of like touching a hot burning stove. Right? You can't reach out and touch it again, it's against human nature. It's against our survival instincts; it hurts too much. Trading is a lot like that and yet that's exactly the thing you have to do if you're going to be a successful trader, you have to touch that hot burning stove again, you've got to take the next trade. And so you need to elevate yourself to a higher level of understanding so that you can look down at all your trades and see that you're results are on a bigger time frame. I kind of compare it to the trees, you know, losing yourself in the trees versus the forest. You have to elevate yourself above your forest and look down and you have to be OK with sacrificing a third of the trees if it means you're going to be able to grow you're forest 2/3 larger, and that's kind of my approach and that helps keep me non-human when I'm trading.

TraderInterviews.com: OK. So, you definitely advocate, at least for yourself, totally automating a system - finding something that works and then executing it automatically, getting out automatically, to take the emotion out of that equation.

TJ: I would say 90%. First of all, the word automation can be interpreted in a number of ways. I don't believe in my computer trading for me first of all. I'm not going to automate my system and push go. I'm going to be there taking the trades. So, I'm pulling the trigger; I'm putting the orders in and not the computer. The computer and my charts are telling me the setups and showing me where the entry is, showing me my targets and stops, but I'm the one taking those trades. But I also would say that you have to mix in about 10% worth of art to trading. There are some things that you just can't program in. The market is a living breathing thing unto itself and, you know, you kind of have to know when to make a little minor adjustment here and there. You have to know to stand aside 5 minutes before a big news event for example. You have to know that when Bernanke starts speaking, you're better off just... you know, the best trade you can make is the decision to not trade at all, that sort of thing. So, there is a little bit of art involved and the more you trade you're market, the more you're going to get a feel for it, the more you're going to recognize certain things that happen each day. And, you know... but again you have to not fall into the trap of trying to be too much of an artist, 10% is the right amount. It's kind of hard to know what that 10% is. There is one way to measure and this is what I would recommend to anybody who is struggling, is that you should keep a separate log with two columns. On one column is "good" and on another column is "bad." And every time you make a discretionary decision or the thing that you would say is the 10% art part to your trading, if you're not furthering your cause two out of three times, 2/3 of the time, then you need to stop what you're doing and just revert back to your system, so you can measure the results of your discretionary decisions and then from there learn from it and that should help your trading over time.

TraderInterviews.com: So, when you say automated, basically you do mean that everything except the actual execution itself. And you mentioned a couple of things, you said, you know, "I don't want to get into a trade 5 minutes before a big economic announcement or in the middle of an important Bernanke speech." But have you tried taking yourself totally out of the picture? Whenever I think of this I always think of war games when they take the human beings out of the launch because they won't turn the keys. Right? And for whatever reason it makes me think of that, but it's kind of a similar situation. You feel like you still have to have the human being there turning the key, i.e., executing the trade even when you get that signal or that order to do it.

TJ: I do because, like I said, let's say I have an entry at... boy, I could even, just looking at the charts right now. Let's say, on the Russell, I have a short entry at 500.2. Do I want to get short at 500.2, 2 ticks above 500, a big round number? You know, one thing I've learned is that round numbers have a real psychological impact, they tend to be a support and resistance level. No! I want to see the price break 500. So, I might make a 3 or 4-tick adjustment and get in at 499.9 or 499.8 and then I'll try to pick up a few extra ticks on the target as well to make up for that adjustment. And how do you automate that? I don't think you can.

TraderInterviews.com: All right. Let's talk about these systems. First of all, how many of these kind of signal systems are you running at any given time?

TJ: Oh, that's a really good question. Well, first of all, I use the system called Universal Market Trader, but there are various iterations of the system. There is the original one that has been out for a few years now and I've mastered it and I use it still. I usually trade the Russell with that. I trade the Russell 233 tick chart. I use tick charts by the way mostly and some volume-based charts. I don't use time-based charts. And so, that particular strategy is a self-adjusting strategy. It tunes itself to current market conditions so the trade signals that it gives you are dynamic. The target and stop on one trade is not going to be the same on the next trade or the trade before; it's constantly adjusting itself. And I think that's really important in a system. So, first of all, that's the one thing in common that all the systems have that I use. Now, I also use a more current version of the UMT on the NQ, on the NASDAQ E-mini, as well as the Dow E-mini. And I should say I also trade T-bond futures, 30-year T-band futures. It's another market that I really love and I think it's a great trading market.

TraderInterviews.com: Now, can you give us kind of the basis or what these systems are looking for in the market? What is giving them keys to find opportunities for you?

TJ: Yeah. The original UMT strategy has three main setups. And what's it trying to do first of all is catching reversals. This is a hard one to learn actually and even harder to take that internal ownership of that I was talking about earlier because one of its main trades is a reversal trade, and it's a counter trend trade. And it's a hard one to make, but basically I have proprietary indicators that tell me when the market is oversold for example and then what confirms is that when my entry is reached to take a long trade. So, that system is trying to catch counter trend moves. It's also then taking advantage of trending moves because it allows you to take pullback trades and continuation trades.

TraderInterviews.com: How important do you think it is for an individual trader to understand exactly what's going on behind the scenes rather than kind of trading on blind faith or something?

TJ: I think it's critical. I think it's the difference between success and failure. You don't necessarily have to understand the math, the algorithms, the real technical thing that's driving that system. That much I don't think you have to understand, although it doesn't hurt. If you can understand that, that's even better. But what you really need to understand is how the system works in practical terms. In real life is it performing? What does it mean if you're winning 65% of the time or even 60% of the time? It means you're losing 40% of the time, and yet that could be an extremely successful system. You have to be able to understand how the losses that it generates are going to relate to the winners because part of that success formula are the losses; you can't get the winners without them. And so to that respect, you have to understand what the system is trying to do. I think that's more important, understanding what the system is trying to do than necessarily understand the math behind it.

TraderInterviews.com: Well, I guess it would also be important to know what the drawdown was on those losers because if you're just making pennies on the winners and you're drawing down huge on losers, there's obviously a problem.

TJ: Yes. And that of course is true, and striving to have risk reward in our favor where our reward is larger than our risk. But I don't need to have two to one; I don't need to have three to one. I'll take trades with one to one, and one puts more risks than reward. It's actually that very same reversal trade I was just talking about and it's counter-intuitive. But the reason why it's so successful partly is because of that slightly larger stop. And I'm not talking about enormous risk versus the reward; it's a little bit more risk and it's got a high wining percentage to justify it. And also that one trade fits it with the other trades; it's a system that you have to trade in sequence; you have to take one trade after the next thus they come in sequence and then we stop when we hit our goals. Typically, the way I trade the system anyway is a goal-setting mechanism that's also dynamic. I'm not trying to take what I want out of the market; I'm trying to take what the market will give me while also quitting positive on most sessions.

TraderInterviews.com: Yeah, you mentioned your goals early on. What are they? Is it a dollar amount or what are you looking for when you set these goals?

TJ: Basically, it's a mantra that I use but it's the power of quitting. And you don't really understand how powerful it is until you actually study it and witness it in action. Basically, in it's simplest form, I'm trying to hit two winners and have a positive result and then I'm done for the day. In other words, if I win one and lose one and lose one again and then I win a second one, if I'm positive, I'm stopping. If I'm not positive, I'm going to keep trading until I am or until I hit my cutoff time, so I have a definite stopping point that combines with that idea.

TraderInterviews.com: All right. So, you have a downside too at a point which if you say I've lost so much for today, I'm done for the day.

TJ: Yes. And that typically that was going to be, you know, at a particular time in the morning because I know how many trades I'm typically going to get and the average size of those trades. So, you know, by 11 a.m. Central Standard Time, if I haven't hit my power of quitting goals, I'm done.

TraderInterviews.com: And why are you comfortable with this two and done, the two winners and done? Is it to keep you from losing... I should the answer the question for you, let me back up. Let me just ask you why you're comfortable with that and I'll tell you what I was thinking after you answer.

TJ: OK. Well, first of all I've had a lot of experience with it. I've had a lot of experience trying to second guess that as well as second guess my own system, it doesn't work. The results are typically going to be better if, well... you know this is a very nuisance question because a lot depends on the person's goal. I mean I have other powers of quitting goals for T-bonds for example that doesn't have to do with winning too and being finished. But in it's purest sense, the two and done idea, one is it's dynamic. It self adjusts. It gives you what the market will give you while allowing you to quit positive on most sessions. And if you combine that with the 2% risk profile on any trade that means you're never risking more than 2% of your total trading capital on any one trade and your system is giving you and edge, 60% or better, meaning you're wining six out of ten. When you combine all that, you've got a winning system and you're going to continually make money and grow your account on a steady basis. The other thing you got to consider is that when you're trading you're investing more than just you're trading capital, you're investing you're time, you're investing psychological capital. I mean, imagine if you hit your two winners and yesterday you noticed it "wow", but you know, there were just so many more winners afterwards, you know, today I'm going to keep trading. And you hit your two winners, you got your positive result, you keep trading. A couple hours pass, you've given back all your winnings and now you're negative on the day. Now, what do you do?

TraderInterviews.com: Yeah, that was what I was going to say, is that I would say that you've probably thought of that and are comfortable with that because a lot of traders give back all their earnings in the afternoon and to avoid that many of them just stop trading, which I think is smart.

TJ: Yes. It's true. And it may not even be in the afternoon. It may just be 10 minutes later, maybe still that morning. I use to trade the PM session a lot and my approach was to treat the PM session as a separate session. So, I would break for lunch and then come back and I would have a one and positive power of quitting goal for the PM session. And I found that I pretty much improved my results on most days. But there were those times when I had a really lousy AM session and came right back with an even worse PM session and that really hurt. In fact that can undo many winning sessions leading up to that point. You know, like you said earlier, you can hit a bunch of winners but then it only takes, you know, one bad loser or one bad session to give back two weeks worth of gains, and so you want to avoid that of course at all cost and you're better off trading less. I mean if I had to sum up my own trading strategy I would say that I'm a minimalist. I believe that you have to have a certain amount of risk exposure in order to make money doing this, and it's a fine line between the right amount of risk, too much risk, and not enough risk. But once you figure out what that is, you really need to stick to it. You don't want to have to expose yourself to unnecessary risk if you don't have to. And why should you? If you can do power of quitting and win on most sessions, quit positive even if it's four out of five sessions you're quitting positive, you're going to grow your account if you keep to that 2% ratio at some point, your one contract becomes two contracts and your two contracts will become three and it will just... you'll keep climbing up, might take a while.

TraderInterviews.com: That's a great distinction there. I wanted to kind of sit on that for a second because you're saying once you figure out what you're doing, increase your size rather than increasing the number of trades to try and get that, which I think is a really important distinction and a lot of traders do the opposite. They try to increase the number of trades rather just individual size of the individual trades.

TJ: Exactly. But the thing is, and that's a good point you're bringing up, I'm not necessarily saying it's wrong to not increase your trades. It's the way you do it that's important. What I like to do is hit my power of quitting goal and I'm done with that market. If I feel I still need to trade or if I want to trade or have more trading in me and it's my passion, it's what I love, it's what I want to do, maybe I'm going to trade a soybean contract and try to get a one win and done approach each day. If I'm winning 60+ percent of the time, I've got one extra trade a day and I'm going to have an edge. And I'm going to little slowly grow that particular account as well by using my 2% rule. And that in itself gives you more trades, you're diversifying another market but you're still sticking with your power of quitting. And so the thing to remember is that power of quitting, you have to emphasize the word power. It is very empowering to be able to quit your session while taking what the market will give you. Not what you impose on the market, what the market will give you. It's dynamic. It's going to self adjust. It might only be 1 tick today. It might be 4-1/2 points tomorrow, but in the meantime, you're quitting positive on most sessions and then you have your cut-off point. Let me tell you, the worst session that I have had on the Russell so far this year and it just happened in June, like a week and a half ago, I lost 7.7 points. That was the worst session! The second worse session was 5 points, and a couple losing sessions with 4 points, a few losing sessions with 3 points, and everything was less than that after that. But on my winning sessions, usually after you go back, you know, you lose 7 points, that was tough! But two sessions later, we broke out to do equity highs. We went on, I don't know, a 12 out of 15 trade winning streak over the next several sessions. Basically, if you look at a healthy realistic equity curve, it should be going up to the right hand side of the 45-degree angle. But if you look at it closely, it's not a straight line. It's a zigzag line. And typically, you're going to be taking one step back and going two steps forward; one step back, two steps forward. But what most traders do is they freak out on that one step back, and it's human nature to not want to touch that hot burning stove so they quit, and they quit a loser, down instead of up. And that's the difference between the 10% that are making it and the 90% that aren't. Most traders are going to be like, "Oh, wow. I just saw several winning trades, I think I'm going to start trading as trading is really good now." And they decide to start trading at that moment. Well, that's the absolute worst time to start trading because the law statistics are just going to catch up right after the winners. You know, that's the end of the two steps forward. The market is going to go in the one step backwards. And then when they experience that and they just can't take anymore pain, they can't touch that hot stove again, they quit! And again, that's the exact wrong time to stop trading, but it's human nature, that's what humans do.

TraderInterviews.com: Let me ask you about that S&P market because so many of our listeners do trade the S&P E-mini. Why was it that you found it wasn't the market for you?

TJ: Well, I've traded the S&P a lot. In fact, in '08 I had a lot of success with the S&P. The reason why though I stopped trading it was first of all, I don't want to have to wait in line to get filled. I mean there were so many times my trade comes up and hits the target and then I don't get filled. And then it backs down; 2, 3, 4 ticks, whatever, now what do I do? Mark it out? Take some more slippage? Give away half my trade? I mean who wants to put up with that? I mean, the S&P trades in quarter points. Right? A tick is a quarter point. And so, 1 tick slippage coming in, who knows how many ticks coming out. There goes the big percentage of your trade profile. Now, if you're going to trade the S&P, you got to trade bigger time frames and bigger trades, and there's nothing wrong with that. I mean, that's great. There's a lot of money to be made and there are some great S&P trading to be done. But for me personally I don't want to be in front of my computer that long. I want to get in and get out. The other day, I finished NASDAQ trading in 10 minutes, two quick winners and done. Is that trader nirvana? Get in there and get out and go home? To me it is.

TraderInterviews.com: And how about the T-bond futures? What is it about that market? Because you don't hear a lot of retail traders trading bond futures but every bond future trader I talked to says it's the greatest market ever, so what is it about that that attracted you?

TJ: Well, it's just a reliable setup. I mean it's a trending market, T-bonds and T-notes. T-notes was my favorite market for a good amount of time. But sometimes it gets compressed and my trade setup started getting really small. So, instead of my average trade being 6 to 7 points, it was 2-1/2, 3, 4 points. That's too small. And then I was getting caught up in the noise and I just realized that you know I can't take this small little setups because the nature of the market is just not that good right now. So, I looked at T-bonds which stretched everything out. That market maybe doesn't trade in quite as high a volume but it has bigger moves and now my setups are a nice size. You know, I'm getting 7, 8 points, 9, 10 points even on some trades. Some of them are small, I've even taken 3 and 4 point trades too. You know, like I said my system is dynamic and it's going to self tune and self adjust to the market conditions. But, it's given a really good solid 60+ percent winning edge. Not one trade that I take my reward will be less than my risk, my reward is always greater than my risk and I apply a different kind of power of quitting to that. As a matter of fact, I love trading T-bonds but I have to really struggle with it because I live on the West Coast. And in order to really drive the benefit from the strategy that I've been testing and practicing I need to be up at 3:34 a.m. and to me that's not realistic. So, I'm kind of struggling with T-bonds for that reason. I think traders on the other side of the world, on the East Coast, in Europe, overseas can do great with T-bonds. It's something you can actually start trading at 2 to 2-1/2 hours prior to the US markets opening and even hit your power of quitting goal. If you wanted to apply the power of quitting strategy, the T-bonds would work fantastic. But I've found that if you just trade straight through and just take all the setups up until 11 a.m., and then if you're still not positive, even allow yourself to take one or two more trades up until noon, Central Standard Time, I mean over the last four weeks, there were only two losing sessions. I mean just doing my own back testing, I think I racked up a 192 net points of profit at $31.75 per point per contract; that's some serious money!

TraderInterviews.com: All right TJ. Well, let's finish up with this - what are some of the things that you want to accomplish this year in your trading that you feel like you're still working on, that you think that you can do better with?

TJ: I think that I need to focus on a swing trading strategy. I actually have one in mind, I just haven't really focused on it. There's a few things I'm trying to kind of resolve and get behind me other areas of my life, and once I clear that I'll have a little more time to focus on some swing trades. And I think that there is a place in every trader's arsenal for a good dose of swing trade.

TraderInterviews.com: I didn't ask you at the beginning but a pretty strict day trader right now?

TJ: Yes. So, I could see myself swing trading some currencies as well as stocks and possibly some grains.

TraderInterviews.com: Excellent! Well, TJ, if somebody wants to find out more about you and what you're all about, give us a website that we can direct them to.

TJ: OK. Well, Netticks.com. There's an E-mini tab, a futures tab I believe, where you could actually get access to my trade room. I mean I have a blog as well but you're probably better off finding it from Netticks.com because it's hard to spell out the URL to the blog.

TraderInterviews.com: OK. Fair enough. Well, hey TJ, thanks very much for your time. I appreciate you sharing some of your philosophies and strategies with us today. Thanks again!

TJ: Thank you too Tim! It was a pleasure. I had a good time.