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Commodity Traders Club News

Commodity Traders Club News

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How I Have Made Money Trading Commodities - J. B.

233

Thanks to the excellent articles in CTCN over the past several months by traders like The Anonymous
Trader and Dave Reiter. I have been inspired to also write about my trading success.

It's true, trading success is more related to the trader's physiological makeup, a trading plan and the
discipline to follow it religiously, and money-management techniques. The trader's methodology, in my
opinion is not as important as these three listed attributes.

When I first started trading commodities, I lost plenty of money, like most new traders do. However, I
didn't realize it at the time, but it was like college tuition for me. The $40,000 I lost, was in fact the
approximate cost of a four-year college degree. The great knowledge gained during those early losing years
was well worth the "tuition cost."

My trading and bottom line has now greatly improved, thanks mostly to my better psychological makeup,
discipline following my plan, and good strict money-management.

Once again, I started out a loser (big loser). As mentioned by Anonymous Trader, for years I was far too
concerned with data services, type of data (perpetual vs continuous vs regular data), quote machines,
charting services, advisory services, standard technical analysis methods, etc.

After years of fairly consistent losing, I realized that its all garbage and trash and will not make you any
money. Discipline, a well defined but simple trading plan based on sound trading principles, good money-
management methods, and the psychology of trading will make you plenty of money.

That's only providing you can shed all the heavy baggage of the believed to be valuable trading tools and
concentrate on these aspects of trading. This will really make you lots of money. You too can do it.

More Information on How to Obtain the "House Advantage" - Dave Reiter

During the past six weeks, I have received phone calls from several CTCN members who were interested in
receiving additional information on my various trading methods and techniques. Therefore, I will try to
expand on my previous article (1/95 issue).

As I mentioned in my previous article, most of my trading is based on repetitive price patterns. My goal is
to locate trades which will offer me a slight advantage over the markets. In other words, I want to "tilt the
odds" in my favor on each trade that I initiate.

During the past four years, I have developed two trading methods based on the principle of repetitive price
patterns. One method is based on long-term price patterns and the other method is based on short-term
price patterns. Please allow me to briefly explain each method.

I've been trading my long-term method every day since 1992. As you know, from reading my previous
article, this method generates about 8 -10 trades per month. On average, each trade is held 4 to 5 weeks.

The reason this method has produced consistent profits for the past 36-mos is because it's extremely
diversified. It trades many markets (currencies, energy, financial, grains, meats, metals and softs).
Whenever I'm losing money in one sector, there usually is another sector that will "pick up the slack."
About two months out of each year, all of the sectors are making money at the same time. Obviously, that's
when I accumulate most of my yearly profits. Unfortunately, I'll also experience a 2-mo period when each
sector is losing money simultaneously.

It's no "big secret, that a large number of commodities will move in a very predictable pattern during
certain times of the year. However, I'm convinced that most traders are not completely aware of these
trading patterns. For instance, most traders (particularly novice traders) probably think that grain prices rise
during the summer (June thru August). However, this is simply not the case most of the time.

234

If you go back over the past 15 years and examine the price patterns for Corn (for instance), you will find
that corn prices will have a definite bias to the downside over 70% of the time throughout the summer
months. Therefore, l always look to short the Grains from June thru August because the "odds" are on my
side. This is the underlying basis of my entire trading method.

This is just one example. I have dozens of other trading patterns that I use each year throughout all of the
commodity complexes. The "secret" to success of this trading method is the fact that all of my trades have a
greater than 50% chance of making money. Once again, the "odds" are on my side.

My short-term trading method is based on the belief that most markets will "gap open" in the direction of
the previous day's closing trend. To profit from the gap opening, I must find a simple way to determine the
market's current trend and establish a position before the market closes. My goal is to liquidate the trade
during the next day's opening range; hopefully with a good profit.

Of the two trading methods, I like the short-term method better because the equity curve is much smoother
than the long-term method. However, the long-term method has a greater profit potential and is much less
time-consuming to trade.

In February, I sent Mr. Green a copy of my account statements and 1099 forms to verity that I have made
over $150,000 during the past-36 months as a result of using these trading methods. However, I did (as Mr.
Green stated in the 2/95 issue) "cover up" the individual trades from my account statements.

Editor's Note: I have found out that some members were somewhat suspicious or doubted the profit claims
because the specific trades were blocked-off. The fact Mr. Reiter chose to block-off or cover-up the details
of his trades on his brokerage statements does not necessarily detract or cast suspicion on his profit claims.

I did that because my trading methods (as you know) are based on repetitive price patterns. Therefore,
many of the trades that I took in 1994, I will also take in 1995. In order to "protect" my trading method, I
"deleted" all trades from my account statements and simply showed the net profit/loss for each month. I am
in the process of writing a trading manual, which will explain all of my various trading methods and
techniques. When the manual is completed, I intend to send a copy to Mr. Green for his review.

I'm always looking for new trading ideas and methods. As you know, the markets are constantly changing
and we need to keep up with those changes. Good luck with your trading.

It is Important to Investigate the Tax Side of your Investing. - Ted Tesser, C.P.A.

Investing May Be Hazardous To Your Wealth! by Ted Teaser, C.P.A. In my last article called "Secrets To
Success," I mentioned the advantages a Trader has over an Investor for tax purposes. Basically, a Trader is
considered, by the IRS, to be running a business, and is given many of the tax advantages afforded such
businesses. An Investor, on the other hand, is considered to be passively "investing" his money, instead of
actively "trading" it. Therefore, he is subject to many limitations which affect his taxable bottom line. Some
major differences are as follow:

Investment Versus Trading Expenses: An Investor must subtract 2% of his adjusted gross income from
his investment expenses before he can deduct them. This includes computer expense (both hardware and
software), data expense, advisory and hotline fees, etc. In addition, if the investor makes over $105,000, he
is subject to an additional 3% exclusion from these deductions. A Trader, on the other hand, gets to write-
off his trading expenses dollar for dollar before paying any tax on his income.

‚ Itemized Versus Standard Deductions: An Investor must itemize his deductions (rather than take a
standard deduction) to deduct any amount of investment expense. If he has no other itemized deductions,
he may not even have enough expenses to take advantage of this, and may in fact, not be able to deduct any
investment expenses at all. A Trader, on the other hand, may deduct his Trading expenses even if they are

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the only deductions he has. He is entitled to take a full standard deduction, which for married joint filers
was $6,000 in 1992, and still deduct his trading expenses besides this.

ƒ Traders Get To Deduct Expenses "Above The Line": An investor must calculate adjusted gross income
(AGI) before he deducts even the limited amount of investment expenses to which he is entitled. This is a
disadvantage because the larger the AGI the more limited are his other deductions (such as medical and
casualty loss). The Trader, however, gets to deduct his trading expenses from income before calculating
AGI.

„ Investment Interest Expense Limitation: The Investor is subject to another limitation on the investment
interest deduction. He may only deduct investment interest (margin interest) to the extent of his investment
income (interest + dividends + capital gains). If an investor has a bad year, and nets a loss, he will deduct
no investment interest at all. A Trader, on the other hand, gets to deduct his margin interest dollar for dollar
as "business interest" on Schedule C.

… Deductibility of Investment Seminars: One of the more obscure aspects of the Tax Reform Act of 1986
was the elimination of the deductibility of investment seminars, plus related expenses. Prior to this Act, an
investor was able to deduct, as an investment expense, the tuition, travel, hotel, meals, and miscellaneous
expenses for attending such investment seminars as the "Annual Traders World Conference". This has now
been taken away from the investor, and currently, no deduction is allowed for such seminars. Traders,
however, can take all such expenses if they are related to trading.

† Section 179 Depreciation: Another significant provision of the 1986 Tax Act was the decrease in
depreciation expense allowed for assets such as computers, faxes, photocopiers, etc. Let's say you bought a
computer for $4,000. If the depreciable life was set at 5-years by the IRS, you could only take 1/5 of the
cost (or $800) as an expense in any one year. Traders, and other businesses, however, were given the option
(called Section 179), of writing the whole item off in the year of purchase (up to $10,000 of write offs, with
certain other limitations). This meant, that if you were a Trader, you wouldn't be limited to the $800, but
rather could deduct the entire $4,000 in the year of purchase. This will become even more important as the
proposed tax changes in Congress raise this amount from $10,000 to $20,000 this year.

‡Home Office Expenses: Although the IRS has cracked down on its indiscriminate use by taxpayers, they
have not forbidden the home office. They have clarified the conditions under which the deduction may be
taken. In order to deduct a home office, you must meet three conditions: it is your only place of business,
‚ the designated area is used exclusively for business, and ƒ you must have a profit in the business you
conduct.

You must also now file a separate form to take this expense, Form 8826. But, and get this, you must have a
business which again means Trader not Investor. In fact, the existence of an office from which to Trade,
even a home office, is one of the requirements for being deemed a Trader by the IRS (we will look at some
of the other requirements in a future article).

In conclusion, filing your tax return as a Trader gives you many significant advantages over being
classified as an investor. Trading is a tough field, and it is vital to use every possible advantage to get
ahead. Claiming "Trader Status," is surely one of the most important strategies for turning in a profitable
bottom line on an annual basis.

Don't Let Deception Become Your Reality - Bob Pelletier - President of CSI

Deceptive marketing techniques for trading systems are not necessarily illegal ploys. An advertisement
may report facts honestly, but take advantage of the trader's desire to accept an inference of profitability.
Over the years many trading methods have surfaced that have made great advertising copy, but could
represent likely deceptions. I recall a system of several years ago which predicted the date of an
intermediate market turning point within two trading days. The promoter alleged he could do this several
years in advance 51% of the time.

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This may appear to be an incredible feat until you realize that "intermediate turning points" as the promoter
defined them, occur at a frequency of 25 times per year. This is an average of once every 10 trading days.
When you factor in the generous "within two days" liberty, you can see that one would expect to be
accurate 50% of the time on a chance basis.

The promoter did nothing illegal in his prediction promise. He was telling the truth in his claim, even
though he may have had a different analysis for coming up with the same result. The effective deception, if
any, was in inferring that such a method can turn consistent profits after commission and slippage. Only the
long-term track record of such an approach would tell the true story about the turning point system's merit.

One last detail of this system that deserves mention: A turning point occurs when the market changes
direction from up to down or from down to up, but you are not told which to expect. A deception? Of
course!

Examining a more recent technologically sophisticated market tool, I do not believe that neural networks
are trading deceptions when applied properly. But I have read articles in popular futures industry
magazines and other publications which prove that some technicians and writers have taken liberties that
create deceptions from them. Labeling a product a "neural network" is not the same as producing a
profitable system.

Neural networks have been used successfully to solve some very complex engineering problems. However,
the developer who uses the term loosely may have easily ignored one or more basic neural network
principals in bringing his approach to the public. Demand explicit, real records before you buy. Make sure
the system you purchase has been proven to produce profits in the markets. The profit-and loss record will
help prove substance over deception.

DECEPTIONS THROUGH HINDSIGHT ANALYSIS

With the many tool-kit programs available to traders today, the unfortunate tendency of self-deception
through curve fitting has been raised beyond acceptable levels. A market trading simulator that takes into
account the aggregate of buy and sell prices for simulated trades is likely to project profits that greatly
exaggerate the system's real-life capabilities. Why? Because the more control parameters used in creating a
trading system, the less likely it is to repeat the simulated past. Failure to consider the high cost of
commissions and slippage, particularly on a short-term trading system, can also grossly inflate simulated
profits. The trader who ignores these truths is clouding his reality and threatening his bank account.

Deciding what method will bear the test of time and produce consistently profitable results is the necessary
step every successful trader must take. A major factor in the success of any trader is how well one
differentiates between a real profit-producing idea and one that deceives us into thinking it will be
profitable.

Comments on Feb 95 Issue - Don McCullough

Your February 1995 issue was a dandy. I must say that if CTCN continues with high caliber articles like in
the past three issues, the competition is going to have a tough time. I'd like to comment on various
statements made in February's issue.

What can we say about Anonymous Trader? A giant THANK YOU for starters for all three of his inspiring
articles. A. T., I'd be just like you and would want to maintain my privacy. I don't like "speaking for others"
and don't really think I have a right to do so, but as for me, you certainly get my sincere thanks.

I recently got hooked-up to real-time data. I'm licking my chops as I watch the S&P make its 1000 to
2500.00 daily moves. I won't start trading with these intraday-day charts until I get a little more data to
work with. I really believe I have valid or good bet signals, but what concerns me most is will I be able to

237

consistently trade my signals? I knew about this very fundamental and serious psychological problem long
before A. T. mentioned it in his last article. However, it's always good to have a successful trader agree
with you. I rank this reinforcement of valid truths about the market as badly needed psychological help for
the up-and-coming trader.

Another valid truth mentioned by Anonymous Trader is, "You learn trading by trading." Real trading in
real markets with real money. I couldn't agree more, and yet I'm sure lots can be learned through thousands
of hours of studying historical charts. I realize, especially psychologically, there's a hell of a difference and
yet I know for sure that a very good type of mental reinforcement (again) comes into play here. With
historical charts, you not only have recent markets to test your signals with, but also all kinds of markets be
they trending, whipsawing or whatever.

In short, I believe psychological reinforcement of valid truths about markets to be absolutely essential in
establishing the certainty one must have to trade his signals in a totally consistent manner. Thousands of
hours effort, even many years may be needed to achieve the needed level of certainty. I expect this is why
most people--including Anonymous Trader's friends--cannot successfully trade even the very best of
systems. You may rightly say, "they haven't paid the price!"

Gary Smith always writes interesting and informed article. I must disagree with both him and Anonymous
Trader about the validity of picking tops and bottoms. Bear in mind, I'm not a successful trader. However, I
have lost very little money in the markets. I attribute this to refusing to act (much) until I'm sure I know
rather than merely think I know how to go about it. I have been more of a student than a trader over an 8-9
year period. However, that in no way means that what I have to say is therefore automatically false.

I am always trying to pick minor and major tops and bottoms. There are certain kinds of breakouts I will
trade, but my main concern is markets' turning points. Before you decide I'm either stupid or naive or both,
consider that the famous trader Paul Tudor Jones, is also a top and bottom picker. He discusses this in the
first Market Wizard book by Jack Schwager.

Rather than tell you my reasons for trading the markets this way, I'd prefer you read Jones's reasons in this
book. We may or may not use the same signals, but I certainly agree with his reasoning. I think top and
bottom picking is, at this point in time and in the minds of most traders, where day trading was a few years
ago. That is, most people at this time strongly believe that you can't successfully trade the markets over the
long run by picking tops and bottoms. I strongly suspect after reading Jones's interview you'll have a
healthier respect for top and bottom picking.

Regarding J.S.M.'s article about Lind-Waldock. This is also my brokerage firm and I wholeheartedly agree
with everything J.S.M. had to say. They are courteous, competent and commissions are reasonable. What
more do you need? I might add that they do offer additional commission discounts if you trade often
enough. You'll have to contact them for full details, but they do state on their "commission card" that they
go as low as $12 per round turn.

The above reminds me that I ought to mention a few other vendors I have a great deal of respect for. One is
Equis Intl. who makes MetaStock end-of-day and real-time investment software. They are tops in my book
in all respects. Their customer support has no equal.

(Let me inject here the fact you can be too cost conscious about the investment software you buy. Hey,
you've got to live with it for many (hopefully) years! Get one of the better programs.) Dial Data has
supplied me with good end-of-day data for several years and at a very reasonable price. Data Broadcasting
Corp., better known as Signal is now supplying me with real-time data and they have been very helpful
with their technical support. My main point is: What would we do without these people? A very big thanks
to all of them.

O. C. R., Sr. Market Analyst - CBOT

238

First, let me state how pleased I am with my subscription to CTCN. I look forward to and learn from every
issue. Now for my contribution:

Michel Arimoto commented in the 2/95 issue that every trader should not forget the importance of the last
trading day, first notice day and Government reports. While these statistics are no doubt important,
sometimes obtaining them is easier said than done.

At the Chicago Board of Trade, we have information about the previously mentioned subjects which are
available free of charge to both our members and the public.

To obtain CBOT Market Information Financial & Agricultural Calendars, call at 312-435-3634. These
calendars highlight important economic releases for entire month and are mailed out monthly.

To obtain last trading days, first notice days, etc., please call the Floor Operations Department at 312-341-
3244 and ask for a Monthly Expiration Calendar.

One more piece of information which I feel may help market participants is the CBOT Professionals
Packet. The Packet contains additional information about CBOT products and services. If you wish to
receive a Packet, please call CBOT Literature Services at 312-435-3558 and ask for the Professionals
Packet.

Thanks for offering such a fine publication.

Market Symmetry - Joe Dinelli

Since no one has sent me a copy of the "Holy Grail," I will pass a small technique that may show that tools
are somewhat helpful in deciding the intent of the market.

The power of the number of "24" and its multiples are very helpful in spotting support, resistance and the
termination of trend. Since what interests me the most in reading these articles are the discussions geared
to actual technical trading. I will try to share some basics from the past.

Cycles with the combination of the number of 24 along with basic divergence can help one's timing
whether to enter a trade or exit. The example I am using is the current April Live Cattle contract. From the
low of 67.28 on 10-11-94 and I add 240 which gives the following numbers of 69.68, 72.08 and 74.48. The
top of this move was 74.90 on 012095.

My cycle work was showing a top coming between 02-21-95 and 02-27-95. As the top was developing, we
can see the basic RSI divergence in place at the 01-29-95 time level. Lower tops followed until the final
sell-off was in progress.

The price level could not hold above 74.47. I might add that the corner on the square of nine was 75.70,
with the high being 75.25. It could not move above that corner. As we can see, the cash market could not
close above 73.10 before it also collapsed with failing stochastic.

The cycle work has to be constantly monitored to produce the acceptable end result and adjusted for the
cash market to the futures. But once it is in phase, one can see the accuracy as this was produced three
months ago.

For the stock trader, the same symmetry is in the stock market, such as IBM stock. For the traders looking
for a black box, thinking that all of the thought and judgement process can be eliminated, good luck as I'm
sure it is beyond reach. Our understanding and gained knowledge is all that will survive.

Book Sources - David J. Slavik

239

I'm a recent subscriber and want you to know how much I enjoy your publication. In February's issue, Joe
Ross' contribution was right on line, when he said "don't let CTCN degrade with negativism." The type of
articles Anonymous Trader and Dave Reiter have submitted are just great.

My primary reason for writing is in response to Robert Miner's trading book recommendations. I tried to
purchase the two books he recommended at local bookstores in the Dallas vicinity, but there was no listing
for them. I also looked in the 1994 Catalog (most recent edition) from Traders' Library and they also did
not list them.

I found a good source for these two books. They are both in the 1995 catalog "Books of Wall Street" from
Fraser Publishing Company, P.O. Box 494, Burlington, VT 05402. For those members that would like to
find them locally, I am listing the ISBN number for each book: A Short History of Financial Euphoria by
John Kenneth Galbraith (Whittle Books, 1990) ISBN: 0-670-85028-4 $16.00 - Fraser Publishing; What I
Learned Losing a Million Dollars, by Jim Paul & Brendan Moynihan, ISBN: 0-9635794-9-5 $28.95 -
Fraser Publishing

Keep up the good work and my best to you in your further success in publishing CTCN.

Reduce Your Risk Exposure, Increase Your Profit Potential, Trade like the Pros Writing Futures
Options Calls & Puts - Jeffrey Notaro

Selling options can be a dicey game. Know your exposure beforehand; trade with strict money-
management and what is considered by most to be a game for the pros, can be a consistent winner for
practically any trader. Past performance is not necessarily indicative of future results. The risk of
substantial loss exists in futures trading.

The two most common views on the subject of writing premiums are very narrow and extreme. The first is
held by the "kamikaze trader." He is willing to risk it all, and then some, to score it big. He likes to sell
options close-to-the money and close to their expiration. Compounding the problem, traditional span
margining allows for an explosive amount of exposure, with the minimum of cash to back it up. Worst of
all, he very possibly could win a few, thus creating a false sense of confidence that will inevitably explode
into red ink.

At the other extreme, there is his alter-ego; he is a risk-averse, safety-first investor. To him, options are to
be bought only; it is simplistic and maximum loss is quantified. What happens all too often is that the
anticipated market move develops slower than expected. A long enough time has gone by to sap all the
leverage out of the option. Compounding the problem is the choice of a strike price that is too far out-of-the
money. He is left with a position withering at a distant strike price with only days left to go. The
disappointing conclusion is that he predicts the market almost perfectly, but his long option barely
responds. Now everyone does not fall into these two categories exactly; but somewhere in the middle of
these two extremes we find the viewpoint held by the majority of traders when it comes to options.

I will present five basic rules that will shake you free from the pack. I will not go into complex strategies or
theoretical breakdowns of option value; that would require the space of a mid-size novel. But if the
following set of simple concepts are understood, practically any trader who decides to dabble in short
options will be more successful.

1. DO NOT SELL INTO LOW VOLATILITY

To be successful, one has to grasp some concept of volatility. Option values are dramatically influenced by
changing levels of volatility. If volatility is low to begin with and the market begins to awaken from a
slumber, you will see a small movement in the futures compounded into a disproportionately large move in
the options. To get a perspective, historical volatility charts are a good place to start; but keep in mind,
much like Seasonals, nothing has to happen exactly the same as it did in the past.

240

Most trading software programs will calculate implied volatility; tracking this over time is probably the
most effective way to know if you are selling hefty premiums or selling yourself too short. No matter how
you follow volatility, you will eventually get a natural feel for what levels are opportune to sell, and what
levels are best left to be bought.

2. DO NOT SELL WITH LESS THAN FOUR WEEKS TILL EXPIRATION

Time decay is your friend. As a grantor of option rights you want to collect your fees as quickly as
possible. Do not fall into the trap of thinking that the shorter you have to hold the position, the less risk you
have. Once an option gets about four weeks till expiration, time decay begins to accelerate faster and faster.
The key is to be already safely positioned before this point occurs.

During its last weeks, an option will fluctuate very sharply in value with a small movement in the future.
You need to have an established position, with a cushion of profit or a tolerance for some wide degree of
fluctuations before this time period begins. To get an idea of the rate of change possible for options close to
expiration, look down a list of those that are going off-the-board soon and see how much they change in
value, by percentage, from strike to strike. The key is to look in that window 30 to 90 days before
expiration for the most time effective points of entry.

3. ONLY SELL NAKED WITH THE TREND

Simple naked options can be the most effective way of taking money out of a long-term trending market. If
done incorrectly, it also can be a quick way to lose many times more than you had hoped to earn on the
trade. Whenever you can comfortably identify a solidly trending market, look to write on corrections and
dips. But wait for the trend to establish itself. By not trying to pick the top or the bottom, your odds of
success increase dramatically. If you are unsure of the market's direction, employ basic trend following
techniques such as a moving average and stochastic. These types of analysis are reasonably trustworthy
when applied to the long-term. Once you really identify a trend, there will be plenty of time to make
money; the key is to be patient.

4. HEDGE WHENEVER POSSIBLE

Short options can be explosive. Hedging a trade with a future or a long option that is close-to-the money
will greatly lower the risk level of the entire position. If you are especially afraid of the market surging too
quickly toward your strike prices, or would just like to capitalize on that move more aggressively, match
each set of shorts with a modest hedge. Care must be taken though to avoid exposing yourself to potential
losses on the hedge portion of the position that cannot be covered by the profits on the other side. If the
whole combination is done properly, it can be one of the most effective short option techniques.

5. ALWAYS SELL THE FARTHEST FEASIBLE STRIKE PRICES

All traders know that it is very difficult to predict any market move with precision. Even if you have a hot
streak, it invariably will be followed by a cooling off period. One of the most enticing features of writing
premiums, is their tendency to become less and less affected by small market changes, as time goes by and
as they end up farther out-of-the money. By moving out to the farthest strike price feasible, your ability to
stay in a trade during adverse conditions is greatly enhanced. If down the road in a trades life-span, the
market suddenly begins moving closer to your strike than expected, that extra cushion of being a little
farther out could make all the difference between a winner and being stopped-out.

In conclusion, no matter what style of trading you do, the basics have to exist: You must judge the market
with a reasonable degree of accuracy and you must use strict money-management and stops. The use of
stop-loss orders does not guarantee that your loss will be limited to the intended amount. The point at
which to throw in the towel with short options is even more crucial, due to their tendency to increase in
value exponentially as the market nears the strike price. If you are patient and conservative, writing calls
and puts can be a lucrative and rewarding way to tackle the futures markets.

241

Special Note: Over the years, as Senior Money Manager and Director of Vision's New York Trading Desk,
Mr. Notaro has been in the unique position to observe literally thousands of traders trade the futures
markets. By observing those that have lost and made money, Mr. Notaro has developed his own common
sense approach to options and futures trading. Mr. Notaro can be reached at Vision LP, 90 West Street,
Suite 21115, New York, NY 10006, 800-892-9606.

Book Review by Axel Brandt from Germany on Trading 0ptions and Futures by Joe Ross

Some time ago, Joe Ross published his fifth book with the unusual name of Trading Optures and Futions
which made me curious right from the start being a futures and options trader myself.

His work is 517 pages strong and deals with the interaction of using pattern, price action and technical
analysis on the one hand and various techniques that can be employed accordingly by playing both futures
and options complementing each other. One of his guidelines here is the statistical fact that 80-90% of all
option contracts will eventually expire worthless. Thus, he's constantly at good risk-reward ratios trades to
put the odds even more in his favor. In this context, Joe says that the odds are strictly against you when
buying options, since the investor has to be correct of price and of the time when the direction will change.

The eighth of 30 chapters the book is made of, deals with the importance of historical and implied volatility
and how they are related. This is really a useful and smart part of the book - like all his previous books,
reflecting that the author is a seasoned practitioner with tons of experience in daily trading.

However, at times Ross gets carried away with an idea sometimes ending in confusing conclusions and
repetitions that certainly don't clarify the good point he's aiming at.

Within the book, Ross goes through all familiar options strategies such as ratio (back) spreads, strangles,
straddles and vertical spreads by illustrating them on an actual chart pattern with reasonable position and
money-management techniques. Furthermore, he never misses describing his follow-up thought once the
trade has been put on. This is definitely one of the strengths of this book, over other literature available in
the markets.

On the other hand, the follow-up action may result in rolling up the short options position with a bigger
number of out-of-the-money options. Here we reach the limit for the average size account, because of the
commissions and possibly higher margin requirement to carry over a longer period of time. Thus, this
cannot be considered a choice for the novice trader involved in futures and options. They should start with
Natenberg's or McMillan's book first.

Reduction of Risk & Using Small Stops - Jim Burke

I've been trading futures for 8-years, some fantastic and others truly forgettable. Only in the last 6-months
have I been able to "put it together" by using precise trading rules. A checklist for entry and exit.

I also reduced my risk on daytrades of S&P from 3 to 8 tics. When I make precise entries, 3 tics is more
than enough to risk. For currencies I use 8 to 10 tics and T-Bonds 13 tics. Some methods I rely on
2,3,5,8,15 and 30-minute bars for S&P, Yen 1-minute bars, 3-minute on Swiss Franc and daily for all short-
term trades on 30 markets.

Even on my long-term trades, I have reduced risk by more than half and very quick to place break-even
trades. I have found that a break-even trade is as good as a profitable trade. Also, if a method requires you
to take a profit at a certain price, place an "OCO" one cancels the other (two orders, either both buys or
both sells).

242

So many traders do not have a trading plan with defined rules for entry, trailing stop, profit objectives and
protective stops. If you don't know which ingredients to use, one cannot bake a cake. I believe if one spends
more time on cutting risk and less time on making high profits, the profits will come.

Minimum Required Capital - Wayne Griffith

A significant reason for failure in futures trading and other business ventures is undercapitalization. Futures
Truth calculates hypothetical net gain (loss) based on three times exchange margin. This is currently
$33,750 (3*$11,250) for an S&P 500 contract, and certainly does not encourage the novice trader to jump
in undercapitalized. However, an experienced trader wanting to know the absolute minimum capital
(ignoring any minimum account size requirements) required to trade a system during the last 12-months
would calculate minimum required capital as the sum of maximum exchange margin during last 12-months
plus maximum drawdown during last 12-months.

I did this calculation for my S&P 'Hourly' Overnight system for 1994. Using the Futures Truth $2,200 12-
month maximum drawdown, I calculated $13,450 as required minimum capital. Using the Futures Truth
$17,600 12-month hypothetical net gain, the 12-month percent gain was 131%. (Futures Truth reported
52%, and ranked the system accordingly, using $33,750 minimum capital.) Things look very different
using this less conservative approach to calculating minimum required capital. Remember that you should
have reserve capital to withstand a possibly larger drawdown in the future. Specifically, heed the wise
advice I heard from John Hill at a Futures Truth seminar ("Your largest drawdown is always in front of
you"), or you risk failure due to undercapitalization.

Simplicity Is Best - Bill Wermine

I primarily trade currencies and live cattle. I use two simple methods for trading. It took more than 10 years
to boil my trading down to simplicity and finally profitability. I tried Gann, Elliot Wave, complex technical
systems, chaos, volatility breakouts, optimizations, other people's systems, etc. Not to say that these
systems are unworkable - just didn't work for me. My conclusion is that you have to find your own way and
simplicity is best. Concentrate on the pure beauty of price, the immediate market action and try to
internalize trading wisdom from master traders. For example, Jesse Livermore said you should wait for
extreme price movement and then place your trade risking a small amount. I have made this wisdom part of
my gut and trading plan and I wait for these opportunities.

I will describe my methods of trading live cattle and currency. If readers have any suggestions or
comments, I would welcome them. I do not trade in isolation and contrary to many others' methodology, I
believe two heads are always better than one.

Fundamentals work well with live cattle when combined with Seasonals and a technical entry system. I
watch the trend of cattle weights, box and load movements and carcass price equivalents. These
fundamentals measure supply and demand. My technical entry system is very simple. I go long as the
oversold RSI begins to tic up and short as it tics down from overbought. I use a 10-bar RSI. I never short in
the winter or go long in the summer. My entry is at the extreme and I risk no more than $1.00. If it fails, I
wait some more. That's it. It is a slow but steady moneymaker.

With currencies, I'm about a 75% technical trader but use reaction to news as my fundamental filter. Over
the years, I have found that what works with currencies are always changing. Sometimes you need to focus
on bonds, then gold, then the S&P, now Mexico, European markets, Japan and always the Federal Reserve.

I keep a little book with columns listing the fundamentals and what the crowd is focusing on. I note crowd
reaction to the news. Along side of that, I record net changes in prices of bonds, all the currencies, CRB
index and the S&P. I will not enter unless all indicators point in one direction. If they are all dollar bull, I
will short the weakest currency at a time the momentum is really pushing hard. I place my stop over a
swing high and will quickly move my stop to break even on the next swing.

243

I have found that the greatest risk of a position is when you first put it on. I have learned from Joe Ross,
that the important thing is to reduce risk as soon as possible and try to put your positions on at the time of
least risk. This method works for me, as it meets both of these criteria.

I would recommend anything written by Richard D. Wyckoff. He earned a fortune by trading the market
based on its own action. Fraser Publishing, Box 494, Burlington VT 05402 has a few copies of Magazine of
Wall St., published by Wyckoff in the 1920's. Mr. Wyckoff always gave trading hints in each issue. Ask for
Eric Hanson, as he is the man in charge of the Wyckoff magazines. They also sell Rollo Tape and some of
Wyckoff's stock market books.

Omega TradeStation 3.5 - Good Product but Poor Support - Matthew Chiang

I purchased TradeStation 3.5 off-line in January. I opted for the 9-month installment plan. Omega's sales
team is pushy and typically phone-order style and tried to sell other options (video tapes) over the phone.
Finally, I asked the salesman to fax the sales confirmation (total monthly charge and any other hidden costs
of ownership, such as maintenance fees). He never did, despite my repeated requests. I hope I won't get
surprise bills later.

They shipped version 3.0 in two days and promised to upgrade to 3.5 later. According to their ad, Easy
Language is easy. But I found their manual oversimplified and few examples were given. Omega offers a
video tape on using Easy Language for $195.

I called their technical support line on how to program a few patterns. I called at different times and days,
but so far have failed to get through the busy tone! There were a few times I was on hold, but after waiting
over 5-minutes I hung up (no toll free #). I then faxed my questions, but no response. I faxed and called the
salesman and asked for the upgrade. He promised to take care of my requests. I received the 3.5a upgrade,
but still no fax reply on the few commands. The 3.5a upgrade is so buggy that three times out of five, I got
a system error.

The help feature is not yet implemented, so I refer to the manual. The 3.5 Easy Language manual has been
expanded, but still inadequate in examples. There are no examples on identifying chart patterns.

I again called the salesman, he quickly routed me to customer service. The lady charged me $35 for
sending the 3.5c upgrade, even though I complained about the buggy program. Now one week has passed
and I still haven't received the upgrade, perhaps 3.5c is still buggy and they wouldn't ship yet. This time I
didn't call, I 'd rather wait for a bug-free version.

Since early January, I have tried no less than 15 times calling Technical Support (try it yourself: 305-xxx-
xxxx). Editor's Note: I took the liberty of deleting Omega's tech support number given by Matthew, as we
don't want their phone line to be tied up even worse with test calls, perhaps even from non-clients. I could
hardly go beyond the busy tone. The best I could get is music while holding and the salesman considers his
job done. I did not order the video tape. I'm not sure if doing so would allow me to do away with their
technical support.

I was disappointed that Omega Research offers customers such lousy service. They should answer faxes, if
not calls. Their salesman should be more responsive beyond closing sales. They should put more examples
in their manuals, instead of asking customers to buy more products to learn how to use the product! Their
BBS has relatively few examples, and most are indicators, not systems. So not much can be learned from
system writing.

Meanwhile, I am using TradeStation 3.0 (it expires in 2-weeks), and always second guessing how to
properly write my systems. If your'e a TradeStation user and could share your knowledge, please call me
(located in Canada) 1-604-540-2568 evenings or fax 1-604-540-2529 and I will call you back.

244

Trading Educators Ltd.
Freeport, G.B., Bahamas - Joe Ross

In my last letter I promised that if I ever wrote an article I would not use my name. However, I really don't
have time to write articles for both CTCN and for my own newsletter. I am currently buried with work. So
with great apologies to you and your readers. I am sending this excerpt from the most recent issue of my
regular newsletter, Traders Notebook. It is so recent, that I finished it only this morning. My own
subscribers will not receive this information until May of this year. Perhaps that will make amends for my
being fickle and not keeping my word.

Please include the above paragraph with the article, because I do apologize for my actions. I could not
resist sending you this article because I'm a man on a mission. I want to help educate as many people as I
possibly can while I'm still able to do so. I plan on retiring one of these days and feel a sense of urgency to
teach people the truth about markets and trading.

My health has been questionable lately. I ask your readers who believe in prayer to pray for healing for me.
Editor's Note: The seriousness of Joe's health problem is worse than he indicates, so please remember Joe
Ross in your prayers.

FIRST NOTICE DAY

There was a time during my trading career when I took potshots at trading around First Notice Day (FND).
"Around" FND refers to three days in particular. In some markets they are, two days before FND, one day
before FND and FND itself. In other markets such as the currencies, the action I will describe takes place
the day before FND, FND, or the day after FND.

Throughout this issue, unless otherwise noted, when I refer to FND, it is inclusive of the two days prior to
FND to one day after FND. Generally, a lot of action takes place around FND. Why? Because that is when
most traders roll their futures positions to the next month. In fact, unless you are a hedger, a registered large
trader, or expect to take delivery, some brokers will not allow you to hold a futures position much beyond
FND. They get panicky if you do, and will usually call you and insist that you get out. I have had brokers
who allowed me to trade well past FND, when I got special permission from them.

As a rule, you need to be out of the market by FND. For those of you who are brave and would like to learn
how to scalp around FND, I will include some illustrations of what to do.

You might be tempted to think that a market will go down around FND because everyone is dumping their
position in order to move into the next month. However, this is not true because for every long, there is a
short. For every position liquidated by selling, there must be a buyer. The people buying are those who
were previously short. They must buy back their shorts in order to rollover. Those selling, are liquidating
their longs.

I have heard it said that over a span of many markets and over a statistically valid period of time, inside
bars comprise about 10% of the market. The price bars involved with FND's seem to involve many of these
inside bars. When they are not represented by inside bars, FND's often show up as underside bars. This
pattern can be upset by virtue of some economic news or change in the fundamentals. But the rule is that
FND bars tend to be small. There is plenty of buying and selling, but the intraday range is not great as
traders exit their positions.

The rub comes when you try to trade off the intraday high or low made by the actual FND bar. The trade
has to be made the following day. Many brokers won't let you initiate an entry trade after actual FND. For
markets whose rollover is greater than one month, look for this to happen on FND for those months having
the greatest Open Interest.

245

Gold offers a good example of this concept. February Gold would have an FND in January. The February
contract is a major Gold contract with lots of Open Interest. March Gold is very thinly traded and you
would not look at the end of February for a Gold FND and expect much to happen.

Even August and October Gold may be unproductive, because after the June Gold goes off the boards,
December Gold may contain the most Open Interest.

Charts in Print Copy

Now let's view the charts above. In these charts I have shown only the bars in and around FND so that you
get a better view. I randomly picked these views.

You may be thinking to yourself, "Why can't I simply do this every day, why wait for FND?" The answer is
you can do this every trading day. In Trading the Minute, I wrote that the breakout of yesterday's high or
low was an entry signal. The difference here is that on the days immediately preceding FND, there is apt to
be better fills because there is more volume. Because of the increased volume, you can even do this trade in
thin markets provided you do it prior to FND. A thin market will generally become even thinner after FND,
and therefore unsafe for this trade. Chart in Print Copy

Once all but those who have a need to be in the market are gone, i.e., after FND, even the most liquid
markets can become quite thin. It's the thinness, the liquidity that makes post FND markets so dangerous.

Two days before actual FND, you begin to watch the market for a smaller than usual bar or an inside bar.
The trick is totally in the entry and it is how I used to scalp from the daily chart before there was such a
thing as daytrading.

If the open of the day after the small bar is a gap outside the range of the small bar, then you trade as
follows:

Gap up, sell one tick below the high of the small bar day. Unless a trade is taken, this signal stays in effect
to include the entire day of the day after the actual FND.

Gap down, buy one tick above the low of the small bar day. Unless a trade is taken, this signal stays in
effect to include the entire day of the day after the actual FND.

‚ If the open of the day after the small bar is within the range of the small bar day, buy 10 points prior to a
breakout of the small bar day high, or sell 10 points prior to breakout of the small bar day low.

ƒ If the open of the day after the small bar is within the range of the small bar day, and the open is less than
10 points away from the small bar day high or low, wait until prices trade further away from that high or
low and then enter when they come within 10 points prior to a breakout.

If FND comes and there has been no inside bar or no small bar, then trade the bar after the FND according
to 1-3 above.

If you or your broker don't like the idea of entering a trade because of the liquidity following FND, then be
aware that many signals come on one day prior to FND. These signals can be freely taken as the market
will be comparatively liquid due to the need to rollover.

The FND trade is a scalp trade. This means you are in for only a day or two. Do not under any
circumstances view this as a long-term trade unless you find yourself in a really good situation and are
willing to roll into the next month.

One management method for the trade could be in accordance with this view: If you are trading a three lot,
liquidate one or two contracts when you have sufficient points that a single contract will cover the costs of
all three contracts. If you liquidate two contracts, you will have covered costs and bagged a small profit

246

equal to twice your costs. Then, bring the remaining contract(s) to break-even. Once the market moves your
way, trail a 50% stop, and as soon as possible switch to the use of natural support or resistance to protect
profits. Another management method is a fixed objective for all three contracts.

I used a continuous Crude Oil chart for this illustration for two reasons: 1. I normally switch to the month
with the most Open Interest prior to FND, so only my continuous charts contain FND. 2. The Crude Oil
rollover is every month, so I was able to show you more instances of the FND phenomenon.

Another reason this trade is different from what I wrote in Trading by the Minute, is the procedure for
taking it. We are looking to sell one tick below the high, and buy one tick above the low. This trading
action is different from getting long just ahead of a breakout of the high or short at a breakout of the low.

If you want to try this technique as a scalp trade off the daily bar chart, then be sure to choose liquid
markets. The objective of the trade is to get you involved in coordination with the appropriate momentum,
i.e., on the correct side of the price action. As previously mentioned, before there was such a thing as
daytrading, I used to scalp the market from the daily chart using this method.

Until, and unless I'm in a winning position, I don't consider staying in the trade overnight. If I do stay
overnight, I will hedge my position by spreading off against a back month or a similar contract at another
exchange. The hedge locks in whatever profits I have earned and gives me overnight to assess the situation
and decide upon any further action for following day. It's always pleasant to sleep on a locked in profit.
Example: I would hedge by selling two half-size Md-Am Swiss Franc contracts for every CME full size
contract that I was long. I would do this if I were in a winning position and long Swiss Francs near the end
of the day. The following day or later, I would drop one or the other sides of the hedge depending upon a
strong directional signal about whether the market was moving up or down. I also might drop both sides,
thereby taking my locked in profit and look elsewhere for a better opportunity.

System Writing in Supercharts - Shawn Halfpenny

I'm a new subscriber, so I thought I'd jump in and contribute my two-cents worth.

I use Omega SuperCharts and find it excellent in most respects (for the price, you can't beat it). The big
drawback is its so-called "Easy Language" in which you program your own systems. It is really very
limited in what you can program and certainly troublesome in expressing what one would think is the most
basic of system ideas. However, l have discovered a few tricks to get around some of these limitations (as
many of you already are aware of - but I'll explain them anyway).

Take the following example of a simple system (it's just some nonsense I made up as an example, don't try
to trade it).

(1) if 0=0 THEN
BEGIN
VALUE1=(H[0]+ L[0] + C[0]) / 3;
VALUE2=(2 * VALUE1) - H[0];
VALUE3=(2 * VALUE1) - L[0];
IF OPEN OF NEXT BAR >=VALUE3 THEN VALUE4=4
ELSE IF OPEN OF NEXT BAR >=VALUE1 THEN VALUE4=3
ELSE IF OPEN OF NEXT BAR >=VALUE2 THEN VALUE4=2
ELSE VALUE4=1;
IF VALUE4=4 OR VALUE4=3 THEN
BEGIN
(2) BUY NEXT BAR AT MARKET;
END;
IF VALUE4=2 OR VALUE4=1 THEN
BEGIN

247

(3) SELL NEXT BAR AT MARKET;
END;
(4) END;
(5) IF 0=99 then (this "then" is outside the white window)
Buy not used
Buy next bar on close
(6) Buy next bar at market
blab blab blab...
blab blab blab...

My frustrations led to experimentation and I discovered that you can "fool" the system editor by doing the
following ...

Start by putting an obviously true statement right off the bat. Use the 'if' that is already present at the
upper left of that little White window, and type in "0=0 then begin" (zero equals zero). Now you're off and
running. You can program in almost anything (that is a legal Easy Language statement, that is) now without
the usual structural restrictions.

‚ That's right, you can even explicitly type in the buy/sell orders. This will give even more flexibility in
your system-writing.

ƒ I found you can mix in a buy order with a sell order and it'll work. It doesn't matter if you're in the "Long
Entry" section or the"Short Entry" section.

„ Put an "end"; here to close out the starting "if" statement.

… Another trick to fool the system editor. Put this obviously false statement here and the five Buy order
options at the bottom will never get activated (which is what you want since your entire system - buys and
sells included - will be within the programming window).

† You still have to put a tick in one of the Buy order selections or your system won't compile right.

So there you go friends, a little trickery, which I hope will help some of you.

On a completely different note, a few questions for Anonymous Trader regarding his interesting Day
Trading methods on the S & P. How do you calculate a Keltner Channel and what do the parameters
(close,9,2) mean? Is it like Bollinger Bands? (Philip Toh's article in last month's issue just left me
scratching my head, sorry Philip). ‚ What do you mean by 2 pivots back, do you mean 2 bars? ƒ Is your
system as effective in other markets, namely T-Bonds and the currencies? „ Do you have a strict definition
of a reversal bar?

Also to make a few member requests, does anybody have NAVA Patterns? How do you like it? What about
the books "Daytrading with Short-term Price Patterns" by Toby Crabel, "Opening Price Statistical Data on
the Futures Markets," by R. Earl Hadady, and "Short-term Futures Trading" by Jake Bernstein. Are any of
these books good or not? Also, just received in the mail today literature from George Lane (stochastic guy)
promoting his seminars in Day-Trading. Promises big bucks. What's up with that?

Oh, most importantly, does anybody know of a good reliable method to predict if tomorrow will be an up
day or a down day or whether tomorrow's high or low will occur first, please call me. Together, with this
knowledge and the research I've done, we can put together a terrific daytrading system.

Joe Ross and Expert Educator - Wayne Roberts

248

When Joe Ross speaks, I listen. He wrote four books and I have them all. The printed word seems passé.
Everybody wants to impress me with their audio videos or software. I wish Joe would make frequent
contributions using his real name and not a nom de plume.

Seasonal Trade - J.S. from California

There is a strong seasonal tendency for T-Bonds to decline for about one week starting on April 15. This
has occurred in about 16 of the last 17 years. Will this decline repeat again this year? I don't know, but I'll
be looking for sell signals around April 14.

Tidbits on Financial Astrology - Carol Murphy

Exact quote from the book forecasting prices.

The conjunction of Mars and Uranus is very significant. It produces unexpectedly galloping changes in
prices of all commodities, including Bullion within a very short duration. If the fall in prices last 10 to 12
days, rest assured that the reaction toward higher levels will be sudden and rapid. Therefore, you should
exercise great judgement in cashing your profit. This conjunction makes sensible operators millionaires
within 2-weeks. 1/29/92, 1/13/94, 1/7/96

Member Requests

Bill Beattie wants recommendations, comments, reviews on Dollar Trader, ADM and Market Profile.

John Jenkins would like to know if anyone has experience or knowledge about any of Bruce Babcock's
systems.

Resource Guide & Editor Reviews

I have been getting Bruce Babcock's Commodity Traders Consumer Report bi-monthly publication(CTCR)
for some time now and find it an excellent value. Not only does Bruce do well-done and straight-forward
reviews of various trading products, but he also keeps track of the performance of a number of well-known
commodity hotline services. Personally, I have enjoyed Bruce's detailed interviews of many highly
regarded and knowledgeable trading experts as the "best" part of CTCR.

For example, the last two issues featured insightful and highly educational question and answer session
interviews with Jake Bernstein, who is easily one of the most knowledgeable and highly regarded trading
experts. Also included was an excellent article on managing risk which featured interviews with well
known traders: Walter Bressert, Steve Briese, Phyliss Kahn, Michael Chishom, Jack Schwager and others.
Bruce also did a detailed review on John Ehlers and his Mesa program. Bruce can be reached at CTCR,
1731 Howe Ave., Ste 149, Sacramento, CA 95825. Phone 1-916-677-7562. Look into this.

I recently had the fortune of viewing Kent Calhoun's well-done and informative video titled "The Five
Most Instructive Lessons of Commodity Trading." It covers several aspects of commodity trading,
including Kent's well-known Vertical Bar methodology. In my opinion it is easily worth its cost. Kent can
be reached at 1-210-238-3084.

Robert Miner is the author of "Dynamic Trader Analysis Report," the monthly publication of Dynamic
Traders Group, 6336 N Oracle Ste 326, Tucson, AZ 85704. Phone 1-602-7973668. Some members may
recognize Dynamic Trader's former name which was Gann Elliott Educators. Robert does an extremely
thorough job of detailed market analysis. His March issue analyzed S&P, Bonds,Gold,DMark & Beans.
Plus, an excellent 56-page special report on the Grain Markets for 1995. Check it out.

249

There has been good interest lately on options trading. There doesn't seem to be many good sources of
information on trading options on futures. However, I have found one titled "Opportunities In Options" by
David Caplan, PO Box 2126, Malibu, CA 90265. Phone 1-310-456-9699. David covers eight market
groups and gives specific advise, including calls and puts, spreads, ratio spreads. He also recommends
which specific strike price to use, and over/under valued options, and trend analysis. Investigate this one.

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