The LSS 3-Day Cycle Method, which is based on the writing of George Douglas Taylor's classic "Book Method" of the Nineteen-fifties, is designed to identify support and resistance. This market strategy is particularly useful in day trading because it identifies zones where the market can be bought or sold with decreased risk. Taylor's contribution to market literature is important in that he correctly identified market "engineering." In a nutshell, Taylor maintained the market was taken lower to create buying opportunities for market insiders or taken higher to create selling opportunities for these same knowledgeable individuals. When put to the test, this pattern does indeed appear to be relevant.
How and why this market "engineering" takes place is not as important as recognizing that it does occur. You don't have to be a long-time market analyst to notice that a lower opening is often followed by higher prices, nor that a higher opening is likewise often followed by declining prices.Additionally, Taylor provided a scenario for the pattern that this engineering created - a 3-day cycle that repeated.
This pattern consisted of:
- A buy day, or "L" day, when the market would be taken lower on the open, providing the opportunity to purchase contracts at favorable prices.
- A sell day, or "S" day, when the market would trade at or near the previous day's high, providing the opportunity to sell at a profit the prior day's long positions.
- A short sell, or "SS" day, when the market would open at an extreme, providing a short selling opportunity for contracts that could be "covered" or purchased lower at the end of the day.
For students of day trading, these patterns often emerge as so-called "gap" openings, when prices are taken "out of line" by buying or selling pressure. To understand why these gaps exist, you only have to consider the conventional wisdom of the marketplace. Among the brokerage communtiy, there is a well-established tendency to suggest the placing of stop-loss orders above and below the previous day's highs and lows. Accordingly, when the market is "taken" into these key stop-point areas, the buying or selling increases dramatically.
It is this "uniformed" stop-loss buying or selling which provides the energy for the market to create unrealistic price levels. Using the ignorance of the uninformed and emotionalism of the market to their advantage, therefore, the smart money engineers simply "fade" - trade against - this short-lived trend. The results are often encouraging. I know what you are thinking: isn't this illegal? Not if placing stop-loss orders is a legitimate activity in the market.
After all, no one forces you to buy a top or sell a bottom, or otherwise act against your own best interest. Thus, the 3-day cycle simply capitalizes on a natural human tendency - the tendency to fear losing money.For you to effectively use LSS, you need to convince yourself that these patterns exist. See for yourself whether the market is ever taken up in order to be taken down - vice versa.
The reason so many market participants do the wrong thing is precisely because this goes against human nature. If the market is going up, you don't want to sell. At that point, the trend is clear. But is it really?
The notion of paradoxical approach to the marketplace is not new. Indeed, the tenets of contrary opinion theory say exactly this: the majority is likely to be wrong. So why shouldn't a counter-trend philosophy prove successful?
We are told that futures trading is a zero-sum game, suggesting that the losers provide the profits for the winners. As far as it goes, this is correct. But this does not mean winner and loser exist in a one-to-one relationship. Far from it. The fact is, the tiny minority earns the lion's share of all the money in the futures market. This is why it so hard to win. Many, many traders contribute funds to the relatively small handful of winning traders. Taylor knew this and this is why his 3-day cycle notion is such a powerful concept.
The knowledgeable traders win because they know something that is not fundamentally understood by the vast majority of fellow traders.Anyone who has spent any time studying the market - especially the actions of the pit traders - will acknowledge that this pattern is common phenomenon. In fact, the tendency for most traders to be wrong is so widespread that one could say it is a rare day when the uninformed players get any opportunity for profit at all.
A typical scenario is a rising market charaterzied by more and more "paper" - public orders - entering the pit as buyers. Since there is indeed a seller for every buyer, although not necessarily in a one-to-one fashion - one big seller may fade one-hundred buyers - the tendency is for the market to rise, stall out, and then crash. The crash, by the way, is helped along by the panicky selling of the erstwhile buyers. Waves of stop-loss orders to sell are triggered as the market plummets. And the big short sellers, who spent the morning selling everything is sight, are calmly standing there in the afternoon, saying, "Buy'em, buy'em, buy'em." They make fortunes doing this.
Taylor had the notion that the tendency of the market to rally or decline could be quantified. This led him to develop the so-called "Book Method," which was essentially a book listing recent rallies and declines, thus measuring where the support and resistance could be found. It is this manipulation of the numbers which is at the heart of the LSS system. Taylor, by the way, called this process "taking the count." If, for instance, the market has a tendency to rise or sell-off so may points from a prior high or low in a recent market, the tendency is apt to persist.
Accordingly, one can create market parameters. This quantification of the market has a benefit beyond the obvious one of telling you where the support and resistance exists. Significantly, it provides you with a framework within which to operate. This means you don't have to pick the absolute low without doubting your analysis. You can buy several times within a so-called "buy envelope," knowing the support should hold. And if it doesn't hold, you likewise know the time has come to exit the position immediately. This ability to "take the difficult trade" is, in my opinion, the key to the success of the LSS system. It gives you the confidence to stay with a winner. And a framework against which to measure the success of a trade.
By setting up parameters, which both quantify and limit risk, you have a viable approach to trading which can stand you in good stead from the first to the last.
Why Day Trade?
There are many ways to approach winning in the market. You can position trade, spread trade, scalp trade or engage in more sophisticated strategies using both futures and options. Day trading is one of the simplest approaches because it involves taking positions which are then exited by the close of trading. There is a decision every day which can easily be quantified. You are either winning or losing money. You are either successful or not successful. Moreover, given today's volatile and liquid markets, this activity can extremely lucrative. Day trading also offers a promising risk/reward ratio.
While not for everyone, this type of trading offers the very best odds for overcoming the prohibitively difficult problem of simply surviving in the market. How many people enter the futures markets each year only to leave after a few months of losses? Believe me, the numbers are high. Since the notion of survival must, by necessity, be the very first rule of trading, this strategy guards against that proverbial trade that goes south on you when you freeze in the market.
More than once, long-term position trading has ended the career of the novice trader who didn't understand the risks. Then there is the question of deep pockets. Most novice traders simply don't start out with large cash reserves. For them, holding overnight positions isn't practical - or safe. I'd rather know my risk and manage it successfully (i.e., take intra-day losses) than leave myself open to the kind of catastrophic losses that can develop overnight. The irony is that even these occasional aberrations in the market tend to see prices ultimately settle back where they started. This is the unkindest loss of all when you are forced out of a winning position on a momentary price swing.
There is an inverse relationship between the newness of the trader and his degree of realism about the market. New traders invariably underestimate the risk. This is why they might buy a S&P contract and go to Europe. But the professionals know better, I like the idea of sleeping will at night. Why risk ruin should an untoward economic or political event occur?
Day trading suits my temperament. Moreover, it is the chosen method of trading of perhaps eighty to ninety percent of all floor professionals Don't you think they would be going overnight if the risk/reward ration favored that approach?
You could make the argument that until recently the technology didn't favor this short-term approach to the market. But with the advent of personal computers, sophisticated software, and on-line data services, today's speculator might as well be standing in the trading pit. In fact, with today's technology, you could make the argument that the off-floor day trader even has an advantage over the floor trader. The technology is that good.
Taylor's Book Method approach is (excuse the pun) tailor-made for today's market. Given today's technology, computers can easily calsulate by and sell envelopes, measure and identify average ranges, profit, and stop placement points and track the positions all in one package. This makes the tedious calculations,and the likelihood of mathematical errors, a thing of the past. While not every market lends itself to the day trading approach, due to a lack of volatility or liquidity or both, there are perhaps eight to ten good day trading markets where you'll find significant opportunities exist in this one time "insider's game".
In short, the advantages of day trading are the profits coupled with the low risk. By monitoring a handful of markets, you can seize the opportunities as they come along. This type of trading will force you to be sharp. But it can extremely rewarding.