How I Make Money by Using Scale Trading Techniques - S. F. From Europe
The reason for my writing is that I have become a convert to the idea of Scale Trading. Therefore I write in defense of Robert Wiest and his system, which was slated by one of your (somewhat ill-advised) readers/contributors.
I presume Robert Wiest is not a reader of your letter. Editor's Note: He is not a CTCN Member. However, I will send him a copy of this article and perhaps he will join. If he is, tell him he can write his own defense. I feel obliged to write something about his system, if only to put the record straight, and perhaps help one or two of your readers who can use these methods.
To state the system "only goes long when the price is perceived to be at historically low levels, and then holds it forever until profitable" is a gross over-simplification, since a decision to start a scale also takes into account much fundamental information.
In the example given in the Feb. issue of CTCN, where sugar fell from 6¢ to 3¢. I presume this move was in line with the fundamentals: I.e., there was gross oversupply. Scale trading would not have been started in this case. If the price of a physical commodity (scale traders are advised not to trade currencies or stock index futures) is near its historic lows and the fundamentals of supply and demand are quite bullish.
I can assure you and your readers that this form of trading is very low-risk. The law of supply and demand has governed prices for centuries, and will continue to do so as long as humans wish to trade and interact with one another.
Your previous contributor gave sugar as an example, and added that more extreme examples were available. I guess there are, but it is not likely he will be able to find anything anywhere near a $30,000 drawdown in a physical commodity from a point where it was ever suitable for scaling.
All trading has some risks. If it didn't, everyone would do it. Scale trading seeks to reduce risk. I agree wholeheartedly with Robert Wiest in his assertion that scale trading offers fair profit potential for low risk. Nobody is going to make 800 per year by these methods, and I presume that this is what stops most people trying it. I can also vouch for Mr. Wiest's assertion that one also needs much discipline, and above all, patience to trade this way.
A lot of patience, but anyone who sticks rigidly to the scale trading system will, in my view, never fail (or at least very rarely fail) to return a small percentage profit each year. Based on my historical testing, 20-40% seems a very reasonable average estimate.
Sure, you'll have drawdowns and paper losses. I have had them, and I have them now. They're part of the system. But overall, I'm profitable, and I sleep at night. If you started your system correctly, the drawdowns will never break you. The losses really will turn to profits later, and not usually years later.
Take corn as a present example. I'm not a farmer, so have no idea what it really costs to produce a bushel of corn. However, as I understand it, and this is also probably over-simplification, the U.S. Government has to step in to help farmers if the price drops below $1.94 F.O.B. the farm. I therefore presume that this is somewhere near their cost, assuming a good harvest with good weather throughout the season. Now, the low of the last ten years is about $1.45, although it has only been below $2.00 after four successive huge crops. Therefore, given the current stock levels, 1995 corn at anywhere below $2.50 looks very attractive to me for scaling.
If you read Robert Wiest's book, you'll see that scales can always be tailored to your own account size and profit goals. I scaled corn late last year and cashed a profit of $200 (less commission) every time the price moved up 4¢, safe in the knowledge that I wouldn't be in trouble until the price dropped to $1.50. At that point, I would have owned about 15 contracts. Sure, the price might have continued to fall from $1,50, which would have been very serious for me, although not catastrophic. But how likely do you think that is? If the price of corn is 30-40 cents below their cost of production, how much corn will farmers plant next year? Not a lot.
I would probably have been rolling a lot of contracts over from this year's to next year's crop, but eventually I would have made my $170 on each contract, plus $170 on each oscillation of 4¢ taken on the way back up. Of course, compared to $1,200 a day, $170 every now and then is not much. But they add up, especially when there are not large minus figures appearing on the statement from time to time as well. And I trade other things too, which also give the odd few hundred dollars from time to time, also without large minus sums.
At the moment, I am scaling soybean meal, soybeans, oats, and heating oil, whilst carefully watching corn and wheat. There are also opportunities in the meat markets. If the July soymeal price drops to 140.00, I shall have to stop accumulating contracts, but I feel that this is highly unlikely. If it drops to 120.00, I'll have given your subscribers a good laugh, but I'll still be in the game. My scale will not be closed until the price hits 185.00. Every time the price moves up $4.00, I make $400 less my commissions. So far, I've cashed several profits, and I only started this scale in December. My oats scales have given me profits, as have soybeans. So far, only heating oil has given me any serious problems, but I shall not be in trouble unless the price drops to 36.00. I'll be out at 51.50. Which heating oil price do you think is the most likely in the next few months? People might well-read this in twelve months' time when the price is at 20.00, and think "I wonder what became of him?", but I doubt it. And meantime, every time the price moves up a bit, I bring in a few more dollars to cushion the blow of any disaster looming down the road.
I have no doubt that you have several readers like this CTCN Trader character. He is clearly a smart chap, and I offer him my congratulations. Good luck to him. We all know that 90% of traders lose over time. I have no reason to suspect that this percentage is different amongst your readers.
So for every CTCN Trader, there are presumably nine losers. (If you survey your readers, they will probably deny this fact, but I think I'm right. Also, I think I'm right in saying that about 90% of people also consider themselves better than average drivers. As this is statistically impossible, I always prefer to rely on statistics coming from information given by bodies like the trading exchanges rather than from privately conducted surveys).
I suspect most of these nine losers-to-be will never try scale trading, because they would much rather be like CTCN Trader (making his $1,200 per day) than me making 20-40% per year. Most people would, myself included. I've already realized this is an unlikely goal for me, as I lack either the ability or the perseverance (or both) of CTCN Trader. I shall stick to my own methods. Regrettably, nine out of ten losers will also find out that they lack something, but presumably via the hard way.Incidentally, if he can't teach friends to do it, what makes you or your readers think he can teach them? Finally, as mentioned earlier, all trading has risks. Any one position trading index futures, bonds or currencies are always vulnerable to gap openings, and it might only need one to wipe them out entirely. Did you know that on Black Monday people got margin calls to produce $200,000 cash, per S&P contract, in one hour? Did you know the bid/offer spread at times that day was up to 100 points (not ticks)? I wasn't there, but have read both statistics in two places. Now to me, that is high risk! Just one day in my lifetime would have wiped out any trader who happened to have gone home long that weekend.
Am I taking risks with my scales? Sure. But what risks? If corn really goes 20% below cost, to say $1.50. How many readers seriously think it will drop much further? I think it is wholly inconceivable it could drop much further. Currencies can trend one way, more or less indefinitely, in a straight line if they like, but crops can't. Eventually farmers will stop planting, and unless demand simultaneously disappears (which has never happened yet), the price can only then go one way: back up, and probably up with a bang.
Dave, you are clearly a nice bloke. I wish you would read Robert Wiest's book before commenting further on the pros and/or cons of scale trading. If you have already read it, then I'll accept that your opinion about few traders being able or willing to use this methodology with success may be correct: hopefully I'm one of the few. Furthermore, since I dislike being made to look silly, I hope I remain one of the profitable few for the indefinite future.
I certainly have a confidence trading now, which I never had previously. You will not like what he has to say about trend following systems. I don't agree with a lot of what he says about chart-reading. I feel it's hard to argue with a law as powerful as supply and demand, and if nothing else, you might enjoy the book just for giving you a different perspective.
I'm sorry I've waffled so much. Scale trading gives me lots of free time to write page after page! (I've cashed four winners this week, but did go three weeks in January without making one trade). Thanks again for your work.
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