Weekly Insights: Futures Trading — The Ultimate Head Game

Futures Trading — The Ultimate Head Game


This educational feature will not address any single topic but instead focus on a few important “odds and ends” that traders will find helpful on their road to more successful trading.

Trading is Indeed a Head Game

I have written extensively about the all-important psychological aspect of trading futures. My conversations with traders continually reinforce the truism that trading is much more about personal discipline and controlling emotions than it is about discovering some great trading method. The one truth about futures trading that “psyches out” many traders is that losing trades are a part of the overall process of trading. If a trader cannot accept the fact that during most years, he or she will likely have a higher percentage of losing trades than winning trades, then odds for his or her ultimate trading success are very low. Most professional traders will cut their losses short on the more numerous losing trades, and let their profits ride, so to speak, on the fewer winning trades—and that’s why they are profitable traders. Remember, it is more important to be profitable in futures trading than to be right. Being right is an ego thing that will cause traders to pull protective stops, try to average down losing positions, and do other things that are not conducive to successful trading.

Protective Buy and Sell Stops Are a Must for Most Traders

The advantage of using protective buy and sell stops when initiating a trading position is that you have an exit strategy in place when you make the trade. It is much more difficult to try and figure out where you are going to exit a trade when you are right in in the middle of a trade. Most veteran trading professionals agree that anyone can enter a trading position, but It is the astute and successful traders that know when to exit a trade. Having an exit strategy, via protective buy or sell stops, in your initial trading plan will take you a long way toward the goal of trading success.

The “Moving Average Envelope” Trading Method

The Moving Average Envelope trading method displays two lines on a chart that are an equal percentage distance from a simple moving average. The moving average line is not visible on the chart. The envelope represents bands that are plotted in a certain, identical relationship above and below a selected moving average. There can be various interpretations and trading rules when using moving average envelopes. Basically, envelopes capture a significant part of price movements. Trading signals are released if prices approach or move away from the envelope.

While several different trading rules are available, the simplest approach uses the price band as an entry and exit point. When the price penetrates the upper price band, you initiate a long position or buy. If you have an existing short position, you close out shorts and go long. Conversely, when prices penetrate the lower price band, you close out long positions and go short.

Perry J. Kaufman is a respected futures trader and educator who has developed more specific trading methods using the moving average envelope theory. He authored a book called, “Commodity Trading Systems & Methods,” published by John Wiley & Sons, Inc., in 1978.

The Bullish Divergence and Bearish Divergence Indicators

Bullish Divergence and Bearish Divergence are technical studies that are available on many computer trading programs.

Bullish Divergence marks occurrences of lows in the market price not accompanied by lows in the value of a certain indicator. If the criterion of bullish divergence is met, a value of +1 will be assigned; otherwise, a value of 0 will be assigned. To use this function, the MACD, Momentum, RSI, or Rate of Change indicators need to be plotted on a chart.

When the market displays falling prices while the values of the indicator are rising, the technical position is said to be improving, since the prices will be declining at a slower rate. Market bottoms can sometimes be forecast when the falling prices are not followed by declining indicators, and the trader can in this case take the desired position to make profits from identifying the bottom in the prices. A useful reminder is that the longer the divergence holds, the likelier it is that the market price will sharply follow the trend of the underlying indicator.

The Bearish Divergence function marks occurrences of highs in the prices not accompanied by highs in an indicator. If the criterion of Bearish Divergence is met, a value of +1 will be assigned; otherwise, a value of 0 will be assigned.

The same technical indicators are applied as with bullish divergence. When rising prices are supported by weaker indicator values, the signal indicates a warning sign of underlying weakness in the price trend. Though the price may be rising, and the natural interpretation implies a perfectly healthy trend, an underlying deteriorating indicator sends out a warning flag to the bulls. Again, the longer the divergence holds, the likelier it is that the price will sharply follow the trend of the underlying indicator.

Bullish Divergence and Bearish Divergence do not have specific formulas, since they are only tools used by traders to define the technical health of a particular market.

As with other computer-generated technical studies, the Divergence and Envelope studies are only secondary trading tools in my trading toolbox. My more important primary trading tools include basic chart patterns, trend lines, and fundamental analysis.


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This material is produced by Higby Barrett LLC Copyright © 2021. All rights reserved. The views expressed and information contained in this publication are believed to be accurate but not guaranteed by Higby Barrett LLC or the Client. Higby Barrett assumes no responsibility or liability for any action taken because of any information or advice contained in this document, and any action taken is solely at the liability of and responsibility of the user.