Marcus Trading System

I think the secret is cutting down on the number of trades you make. The best trades are the ones in which you have all three things going for you: fundamentals, technicals, and market tone. First, the fundamentals should suggest that there is an imbalance of supply and demand, which could result in a major move. Second, the chart must show that the market is moving in the direction that the fundamentals suggest. Third, when news comes out, the market should act in a way that reflects the right psychological tone. For example, a bull market should shrug off bearish news and respond vigorously to bullish news. If you can restrict your activity to only those types of trades, you have to make money, in any market, under any circumstances.

Marcus himself would trade more frequently than his strict guidelines suggested. But the thing that "saved" him, he said, was a willingness to "enter five to six times the position size" when all his criteria were met, versus other trades that "broke even and kept me amused."

The Marcus Grading System

Your humble editor is determined to improve as a trader every single year (if not every single month, week or day). One 2010 resolution is to make fuller use of Michael Marcus' wisdom in terms of trade selection... and to implement that wisdom in a specific, concrete way.

To that end, yours truly now introduces the "Marcus Grading System." The Marcus Grading system - inspired by the Market Wizards interview - is a simple means of "grading" potential new trades, based on the key factors Marcus cited: fundamentals, technicals and market tone.

The below table shows how it works:
The Marcus Grading System
Fundamentals

Technicals

Market Tone
• Rate 1-9
• 1 = max bearish
• 5 = neutral
• 9 = max bullish • Rate 1-9
• 1 = max bearish
• 5 = neutral
• 9 = max bullish • Rate 1-9
• 1 = max bearish
• 5 = neutral
• 9 = max bullish
Max Bearish Example: 111

Neutral
Example: 555

Max Bullish
Example: 999

The Marcus Grading System uses a simple zip-code type approach. The "grade" itself is just a three-digit number... each digit corresponding to fundamental, technical and market tone rank (in that order).

As you can see from the table, "1" is maximum bearish and "9" is maximum bullish. If you are looking to go short, you want a grade tilted toward low (bearish) numbers. If you are looking to go long, you want a trade tilted toward high (bullish) numbers.

A "9" is not necessarily better than a "1" in this regard (unless you have a problem with going short). The thing to avoid, though, is the muddle in the middle. A "5" is the equivalent of saying "hard to say either way."

Let's walk through some quick examples.

Max Bearish Example: 111

A trade with a rating of "111" (three ones) would be maximum bearish. The fundamentals would be coyote ugly - huge oversupply, grossly overbought, disaster looming, et cetera - and technicals and market tone would be correspondingly ominous. For instance, imagine a clear breakdown from a rolling top formation as uneasy hope morphs into dull panic.

This type of shorting opportunity is rare indeed... like pocket aces on the button in a poker tournament.

Neutral Example: 555

A trade with a Marcus rating of "555" would be pure blah (and best avoided).

With neutral fundamentals, neutral technicals and neutral market tone, the next directional move becomes a coinflip proposition... more or less anyone's guess. You want to stay away from trades that wind up in this neutrality "dead zone," because there is little point participating in the market (and incurring transaction costs and slippage) without a clear edge. The more fuzzy (i.e. neutral) the trade, the smaller the size... if you even play it at all.

Max Bullish Example: 999

A trade with a Marcus rating of "999" would be maximum bullish. An example of this type of trade might be a deeply oversold market, having just registered a high-volume breakout from a consolidated base, with some type of aggressive fundamental catalyst fueling a radical shift in investor perceptions.

Again, max bullish trades are not very common... but when they come along, you want to back up the truck (within the context of risk management parameters of course).

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Rare Extremes and Intuitive Feel

If you elect to use the Marcus Grading System on a regular basis, you will not see very many "max bullish" or "max bearish" opportunities. A more realistic grade might be something like "876," where fundamentals are strong but not screamingly so, the chart looks decent but not fantastic, and market tone is modestly positive.

The idea is not to assign an overly precise number to every trade. Instead, the Marcus Grading System acts more like a filter... a means of expressing intuitive feel. If one of the numbers looks especially off, then maybe that is a sign to not take the trade... or to wait things out a bit and see if conditions improve.

On the whole, the Marcus Grading System could improve your trade selection (if you choose to use it) by reminding you to always check in on the "big three" factors - fundamentals, technicals, and market tone - and also by acting as a sort of pre-flight checklist, filtering out potentially hasty or unwise trades.

Last but not least, it's important to note that conditions change. An open position can see its Marcus Rating change too, perhaps significantly so, over time. By routinely assessing open positions with a fresh eye via the Marcus Grading System, the trader has better odds of spotting a problem early. If you want to see it in action, Macro Trader will be applying the Marcus Grading System to all open positions in 2010.