What's Trader Tax Status Worth?

The Internal Revenue Service has two tax classifications for individuals who buy and sell securities, mutual funds, options, futures, commodities and other derivatives: Trader and investor.

The minority who trade for a living under the IRS definition are classified as traders and afforded an attractive menu of tax breaks. The majority, who trade part-time in addition to full-time W-2 employment or as a retirement hobby, do not enjoy the tax advantages that accompany trader status.

So, how do the two match up come tax time? If your trading left you in the black, you could save thousands. If your trading resulted in a substantial loss, however, the ability to write off that loss in the year it occurred could result in a windfall of $20,000 or more.

How Traders Trump Investors

As a trader, you trump investors in two main ways: You can fully deduct all of your trading expenses, and you can write off 100 percent of your losses in one year (provided you elected the mark-to-market accounting method).

Investors who itemize their deductions on Schedule A are limited to a handful of deductible investment expenses, including legal and accounting fees, investment counseling and advice and investment newsletters. These must be listed as miscellaneous itemized deductions and can only be deductible to the extent that they exceed 2 percent of adjusted gross income.

As a trader, however, you can deduct all your business-related expenses, including your data feed, dues and subscriptions, equipment, utilities, seminars, transportation, travel and entertainment. You can also take advantage of the home office deduction if you work from home.

So far, the IRS has left further delineation in the hands of the tax court, whose rulings tend to uphold the denial of trader status without shedding much light on how individuals might qualify for trader status in the first place.

Expense Deductions Add Up Fast

Here's how the additional expense deductions would benefit Janet Trader compared to Johnny Investor if both had identical trading gains and business expenses. Note that Johnny Investor is subject to the 2 percent threshold for the few deductible expenses he is qualified to claim:

• Total household income: $140,000
• Trading profits: $40,000
• Trading expenses: $24,230
• Janet Trader's tax savings: $7,269
• Johnny Investor's tax savings: $1,644
• Benefit of trader tax status: $5,625
• Risk insurance: The Capital Loss Deduction

When it comes to covering losses, traders fare even better: The IRS allows traders who elected mark-to-market to write off their entire loss in one year. You can even apply the loss to taxable income from past years and generate a tax refund!

Investors, meanwhile, have a maximum allowable net capital loss of $3,000 in any tax year. That means if you lose more than $3,000, your only recourse is to carry over the remaining balance until it's used up but, again, only to a maximum of $3,000 a year.

Here's how a $40,000 loss would affect Janet Trader and Johnny Investor. (Note that Janet Trader was able to offset her regular $100,000 income with her $40,000 loss while Johnny Investor is limited to the $3,000 capital loss deduction.)

• Total household income: $140,000
• Trading loss: <$40,000>
• Trading expenses: $24,230
• Janet Trader's tax savings: $19,269
• Johnny Investor's tax savings: $984
• Benefit of trader tax status: $18,285

Investors also face another limit: They may only deduct investment interest up to the amount of their net investment income, defined as total investment income (earnings, interest, dividends and royalty income) less the deductible investment expenses previously discussed. Any investment interest that exceeds that cap is non-deductible but may be carried forward to future tax years.

One of the best ways to secure and protect your trader tax status is to trade as a business entity. The IRS treats business filers in a far more consistent and advantageous way than it does individual traders.

excerpted from Jim Forester, Tax Director of Traders Accounting

Trader Tax Tips

Protect Your Trader Tax Status
Fail any part of this three-part test, and you'll be treated as an investor, not a trader, for tax purposes.

1. Seek to profit from daily market movements in the prices of securities and not from dividends, interest or capital appreciation
2. Execute a considerable volume of trades
3. Carry on this trading activity with continuity and regularity

What's at stake? Investors are subject to the 2 percent threshold for deductible investment expenses (and, hence, cannot write off most of their expenses) and are limited to a $3,000 capital loss deduction.

But, as a trader, you can write off 100 percent of your expenses, and, if you elect the mark-to-market (MTM) accounting option, you can also offset all of your losses against income. However, if your trader status is denied by an IRS audit, you lose your MTM election.

File a Timely Extension

Because of the complexities of filing a trader tax return, it's often a good idea to file an extension. If you file an Automatic Extension by the tax deadline of April 15, your tax deadline is automatically moved to August 16.

Bear in mind that an extension only gives you extra time to file; you must still pay at least 90 percent of what you owe by the original April 15 deadline, or your Automatic Extension will be ruled invalid, and you'll be slapped with late penalties of 5 percent per month (up to 5 months), as well as interest expense on all tax payments after April 15.

Report on the Correct Forms

Many traders mistakenly report all trading income on Schedule D (Capital Gains and Losses). To avoid this common error, if you elect mark-to-market accounting, you should list your trading activity on Form 4797 (Sales of Business Property), and, if you trade in futures or Forex, you should report these trades on Form 6781 (Gains and Losses from Section 1256 Contracts and Saddles).


Prepare before Proceeding with Mark-to-Market

The rules of mark-to-market election couldn't be clearer: To use MTM within this year, you must have notified the IRS of your election by the tax deadline last year. You would then begin using MTM this year by enclosing IRS Form 3115 along with your tax return.

But, before you make the switch, make sure you separate your investment holdings from your trading stocks and options. Why? Because, unless they are clearly separated, you will be required to mark them to market at year's end and report any gain as ordinary income. That could prove disastrous for stocks that have greatly increased in value over time.

The decision to elect mark-to-market is not to be made lightly; it can have a profound positive or negative impact on your taxes. Once you elect MTM, there is no going back without IRS approval. Consult a trading tax professional to see if mark-to-market is right for you. Again, remember that MTM is an accounting method only for traders who trade as a business.

Include a Complete Trading Log

Traders who elect mark-to-market are often under the misconception that they need only provide their beginning and ending balance on their tax return and not account for the trades in between.

The IRS has requested that every trader send in a schedule showing all of his or her trades for the tax year, whether he or she is filing as a trader or investor. The lone exception is for those trading in futures or Forex; you need only submit a net figure (using IRS Form 6781).

excerpted from Jim Forester, Tax Director of Traders Accounting

Vengeance Trading!

A sure recipe for Failure!.

Be A Risk Seeker!

Seeking risk, not avoiding it, is the nature of day trading!

How To Profit From Nasdaq Divergence!

BL Asked: Rudy, did you trade any 15/30 charts today?
Rudy Response: TSO on 4th bar b/d on 30 min NR7. Was a gap fade play.
Friday, January 25, 2008, was a classic example of a gap fade day. I was able to profit from this market reversal because of an intimate understanding of the convergence/divergence of the general market action verses my market leaders performance. Here is how:

At about 10:00 am, I completed my watch list scan for gaps.

1. My Hit List compromised of more gaps on the upside than on the downside. A bullish sign!
   
2. My Market Leaders were 5 longs and zero shorts. Although, long opportunities were limited, but with no shorts, I was still feeling bullish!
3. However, upon review of the quality of my market leaders, I was finding nothing to get excited about. The charts were wide and loose, lots of tails, wide open range bars, generally sloppy. A Bearish sign!.
4. By 10:30 the action of my Market Leaders was leaving a lot to be desired. HOG, a big volume gapper had an unexpected massive sell off. In fact, none of my market leaders were breaking-out and following thru to new highs. Instead, they were either stalling or breaking-down. A truly bearish sign!
5. The Nasdaq behavior, on the other hand, was singing a different tune. It had a wide open range marabuzo bar, above the prior day's high. A bullish sign! But what about the action of my leading stocks? They were limited in choices, sloppy, breaking-down, and "nothing to get excited about". In other words, where were the leading stocks to propel the Nasdaq to higher ground? A classic divergence from the Nasdaq trend. A bearish sign!
6. As such, my market bias was weighted towards the bear side, hence my short trade in TSO on the 1/2 NR7 bar breakdown! (i.e., smallest candlestick bar I refer to as NR7)

Hope this helps, Rudy!

Donchian's Trading Guides

General Guides:

1. Beware of acting immediately on a widespread public opinion. Even if correct, it will usually delay the move.

2. From a period of dullness and inactivity, watch for and prepare to follow a move in the direction in which volume increases.

3. Limit losses and ride profits, irrespective of all other rules.

4. Light commitments are advisable when market position is not certain. Clearly defined moves are signaled frequently enough to make life interesting and concentration on these moves will prevent unprofitable whip-sawing.

5. Seldom take a position in the direction of an immediately preceding three-day move. Wait for a one-day reversal.

6. Judicious use of stop orders is a valuable aid to profitable trading. Stops may be used to protect profits, to limit losses, and from certain formations such as triangular foci to take positions. Stop orders are apt to be more valuable and less treacherous if used in proper relation the the chart formation.

7. In a market in which upswings are likely to equal or exceed downswings, heavier position should be taken for the upswings for percentage reasons - a decline from 50 to 25 will net only 50% profit, whereas an advance from 25 to 50 will net 100%

8. In taking a position, price orders are allowable. In closing a position, use market orders."

9. Buy strong-acting, strong-background commodities and sell weak ones, subject to all other rules.

Technical Guides:

1. A move followed by a sideways range often precedes another move of almost equal extent in the same direction as the original move. Generally, when the second move from the sideways range has run its course, a counter move approaching the sideways range may be expected.

2. Reversal or resistance to a move is likely to be encountered

   	0n reaching levels at which in the past, the commodity has fluctuated for a considerable length of time within a narrow range
   	On approaching highs or lows

3. Watch for good buying or selling opportunities when trend lines are approached, especially on medium or dull volume. Be sure such a line has not been hugged or hit too frequently.

4. Watch for "crawling along" or repeated bumping of minor or major trend lines and prepare to see such trend lines broken.

5. Breaking of minor trend lines counter to the major trend gives most other important position taking signals. Positions can be taken or reversed on stop at such places.

6. Triangles of ether slope may mean either accumulation or distribution depending on other considerations although triangles are usually broken on the flat side.

7. Watch for volume climax, especially after a long move.

8. Don't count on gaps being closed unless you can distinguish between breakaway gaps, normal gaps and exhaustion gaps.

9. During a move, take or increase positions in the direction of the move at the market the morning following any one-day reversal, however slight the reversal may be, especially if volume declines on the reversal.

   www.seykota.com

Costly Mistakes!

A system's purpose is to ensure that we do not miss a breakout when a real trend comes, because missing a really strong trend is lethal - so lethal that we are willing to pay the price of many small losses, just in case the real one emerges.

Each entry doesn't guarantee a profit, in fact, each entry likely becomes losses. However, the odds is that if you follow it consistently, in the long run, you come out ahead.

Composite Of A Losing Trader!

The composite of a losing trader would be someone who is highly stressed and has little protection from stress, has a negative outlook on life and expects the worst, has a lot of conflict in his personality, and blames others when things go wrong. Such a person would not have a set of rules to guide their behavior and would be more likely to be a crowd follower. In addition, losing traders tend to be disorganized and impatient.
-Dr. Van K. Tharp

The Accountant In Me!

LP: my watch list is pre-screened for stocks trading above $50 with 50D volume greater than 1.5mm, mostly in the technology industries. These are volatile and liquid stocks. Low volume gaps tend to fade, especially when the indices are also breaking down.

Entry criteria for the fade moves are bearish candlestick reversal top, for gap-ups.

As far as identifying them, they often reveal themselves, loud and clear, on the 30 min chart.

The basis of my entire trading system is to patiently stalk the 30 min chart for my sixteen set-up criteria (8-long/8-short). I know it sounds difficult, but when you can calmly review a 30 min chart, every half hour, for specific patterns, you will ultimately make better judgments.

Or perhaps, as I am beginning to believe, it is the accountant in me that enables me to conduct such "detail analysis" from a spreadsheet point of view.

One of the conclusions I am leaning towards, is that a crafted trading method must be as a result of our career/educational background.

Hence, my propensity towards such an analytical spreadsheet methodology.

Understand Your System!

After some thinking, I have come to the conclusion that most traders are finding it quite difficult to execute Trader X and Maoxian KISS system. I now believe that the problem is not that they lack the dedication to follow the system, but the inability to recognize the patterns as they are "unfolding". As such, I will attempt to address some issues that can alleviate this dilemma.

1. First, consider building a trading system only around the 1/2 hour candlestick reversal bars: Marabozu and Hammer. Such powerful bottom or top reversal bars are often seen at turning points in a stock trend, and occur rather frequently to merit consideration. A quick review of chart patterns will confirm such observations.
2. Second, build a trading system that takes into account a stock emerging intraday trend. Your goal is to identify several pivotal points of entry within the ever-changing trend of a stock, for example: (1) a gap trade with a normal pullback and a candlestick reversal top/bottom (hammer or marabozu), and NR7. (2) An open range breakout from a 1/2 hour NR7, that signals a low risk entry. (3) an open range breakout with a normal pullback and a candlestick reversal top/bottom (hammer or marabozu), and NR7.
   
3. Third, use a daily worksheet to checkoff your half hourly screening when monitoring your hit list. This will (a) compel you to look at the half hour chart on a routine basis. (2) Allow you to monitor for your various set-up criteria as the stock trend unfolds. (3) Keep you focused and help you develop an "intuition", or 6th sense, regarding your setup criteria and the trend of the stock.
   
4. Fourth, by monitoring several "focus" stocks every half hour, you automatically increase the opportunity to find a setup pattern that matches one or more of your predefined criteria. This will enhance your ability to identify at least three high probability trades per day.

By acknowledging that a trading system must take into consideration the ever changing evolution of a stock intraday trend, the importance of a daily worksheet to enforce the psychology of discipline, focus and patience in executing your system, the better you will succeed in "sticking to a trading plan".

A Day Of Reflection!

M.L. King, Jr. on August 28, 1963

"I have a dream that my four little children will one day live in a nation where they will not be judged by the color of their skin but by the content of their character."

GOOD TRADING IS EFFORTLESS!

"In trading, just as in archery, whenever there is effort, force, straining, struggling, or trying, it's wrong. You're out of sync; you're out of harmony with the market".

"The perfect trade is one that requires no effort!

Lack Of Emotional Discipline!

Most people lose money because of lack of emotional discipline -the ability to keep their emotions removed from trading decisions.

Dieting provides an apt analogy. Most people have the necessary knowledge to lose weight—that is they know that in order to lose weight you have to exercise and cut your intake of fats. However, despite this widespread knowledge, the vast majority of people who attempt to lose weight are unsuccessful.

Why? Because they lack the emotional discipline.
-Victor Sperandeo

Meanwhile ..... Time Marches On!

Wishful Thinking!!

Don't confuse Day Trading with Day Dreaming!

Happiness' Secret Is The Acceptance Of Misery!.

Fusion Of Methodology and Psychology!

BL comment: looks like MCD didn't break dn.

Rudy response: mcd did breakdown on the 30 min, 5th bar low (or 10th bar, 15 min), although it failed to meaningfully follow thru. In addition, consider the following:

While not every breakout result in a profit, no profit will ever be made without a breakout!.

Another good old adage to remember is: "You got to be in it, to win it"! Hence the trade.

The point though, it was a perfect set-up because of: (1) Retracement (a brief rally after the gap down), (2) Reversal (first down bar after brief rally), and (3) Confirmation (internal bar = low risk entry).

Also take into consideration the three principles of my philosophy as it interacts with my trading method: Discipline, Focus, Patience.

Discipline was achieved by stalking my watch list for gappers and narrowing my scan to a hit list of less than 15 stocks. It is also, the ability to periodically review the 30 min chart every half hour for my setup criteria.

Focus is the ability to stay oriented to my specific setup requirement and not being distracted by the chaotic behavior of "other" stocks.

Patience is letting the trade come to me by auto triggering my open market order.

Mcd is, therefore, a perfect example of the cumulation of methodology and psychology fusing together.

The very essence of trading which most traders fail to bridge!

So Many Tears!

No Holy Grail In Daytrading!

There never was and there never will be anything secret or new about the markets, not now, and not a hundred years from now.

Why? Because the more markets change, the more they remain the same!

The best we can ever hope to achieve as traders, is a favorable probability from trading our "perceptions of market behavior". And, like snowflakes that never was, there never will be any two traders who think exactly alike, in the ever changing present of NOW!

Market "Secrets" I am never afraid to divulge because there are no such things.

Personalized trading methodology, on the other hand, while guarded with strenuous envy by some traders, are quite difficult to teach, because the backbone of any trading system is a function of the trader's unique psychological nuances.

How I Maintain Focus, Patience, & Discipline!

LP: Once you have compiled your gappers from your morning scan: (1) on average how many stocks are you stalking intraday? (2) How do you track every 1/2 hour? Do you use a daily worksheet to monitor (a) symbols, and/or (b) checkoff 1/2 hourly increments expiration(eg: 11:30; 12:00, 12:30, etc), (c) or a simple eyeball scan every 1/2 hour?

My System For Achieving Discipline, Focus, and Patience When Daytrading:
I personally use a daily worksheet of 160 stocks with virtual volume at 10:00 am calculated for each one. Once I determine the gappers, I screen 10:00 actual volume with virtual volume, isolating unusual activity. I now create a 2nd list on the same worksheet, usually about 15 stocks to focus on intraday. I will actually use this worksheet as a checklist to track symbols and to checkoff 1/2 hourly expirations.

The reasons for my daily worksheet are as follows:
(1) By 10:00 am, I have my Hit List and I am positioned to trade the first one hour of the market opening. If I spot a hammer or marabozu bar and NR7 on the 15 min chart, I take my first trade setup.

(2) After 10:30, I then switch exclusively to 1/2 chart and stalk for the first green/red bar after a fib retracement. Likewise, if I spot a hammer or marabozu bar and NR7, or IB, on the 30 min chart, I am in positioned to take my second trade setup.

(3) By analyzing my worksheet list every 1/2 hour, I can flow with the market and monitor for base and break patterns that are prepping for possible breakouts, my third potential trade setup.

(4) A fourth trade setup are anemic volume gaps that fade on an evening/morning star candlestick reversal patterns.

(5) My daily worksheet keeps me focused. I know exactly what stocks to daytrade. I am not panicking or distracted by the chaotic behavior of other "unfamiliar" stocks.

(6) I can walk away from my desk, and upon my return continue where I left off without any concern of loosing momentum.

(7) By manually checking off 1/2 hour time schedule, I am being disciplined about my half hourly routine. This prevents me from distractions that can lead to missed signals.

(8) I have found from hard experience that eyeballing charts lulls you into a false sense of security. Often times, I miss signals because I am distracted from executing my 1/2 hourly review, and many times I am left with a feeling of conflict and confusion from the casual eyeballing of chart patterns.

My simple system of a daily worksheet and half hour checkoff routine compels me to be focused, disciplined, and patient ... essential traits most important to daytrading!

Hope This Helps. Rudy

Build A Better Mouse Trap!

Is your system of tracking and stalking the half hour chart for internal bars and NR7 proving to be intimidating?

Here are Some Simple Suggestions To Beef Up Your Trading Strategy:

(1) When compiling your morning Hit List, instead of screening the entire universe of equities for morning gaps, why not narrow your search to a pre-defined basket of carefully chosen stocks. For example:

(a) Stocks trading between $50-$100, with 50 day average volume greater than 2mm. This refined list will mechanically include stocks with solid liquidity and good volatility. Afterall, it is far easier for a $50 stock to move $1 (or 2%), while a $20 stock will require a whopping 5% price appreciation.

(b) In addition , you can restrict your scan to include only industries that are known for its technological innovations, such as, Retail, Internet, Leasure, Medical, Telecom, Computers, Internet, Electronics, etc. Furthermore, by excluding staple industries, such as, Utilities, Chemicals, Food, Building, Commercial, Machinery, Insurance, Tobacco, Food, etc., your morning gap scan will be constricted to a basket of less than 200 stocks!

(c) By limiting your gap search to a well defined list, you are automatically weeding out stocks that are low volume movers, choppy price patterns, low price volatility, and non-performing industries.

(2) Once you have a focus list of morning gappers, simple screen for above average volume.

(a) A simple mechanism for calculating virtual volume: if the stock's 50 day volume is 2mm, by 10:00, virtual volume should be 500k (2mm x 2 x $0.25) /2. (assuming end of day volume s/b twice 50d, and by 10:30 25%)

(3) Your intraday Focus List should now be less than 15 stocks. Once every one half hour review the 30 minute charts for IB and NR7, and trade accordingly!.

A simple yet sophisticated datytrading strategy!.

All The Computer Some Traders Need!

HOPE IS A FOUR-LETTER WORD!

Winning Qualities Of Good Traders!

1. They don't fight the market, and they don't become threatened or defensive.
2. They accept that there will be periods when they see things well and periods when they don't.
3. They get smaller when they realize their trading isn't working.
4. They avoid digging large holes for themselves, but they also don't stop trading.
5. When they're seeing things clearly, they leverage their strengths.
6. They don't press to catch up and make money.

All traders lose money; it's how you trade when you're down that makes all the difference!.

Separate Your Emotions From Self!

"Once you can clearly spot the rising of disappointment or excitement as Objects separate from yourself, you become less identified with those objects and they have less effect on you"!.

Run Like A Thief!

Consider the following, every trade must have two objectives: (1) procedure to manage initial risk, and (2) method to maximize profits. Two faces of the same coin!.

As traders we are trading our "hope and aspirations", in the "belief" that the market "may" accommodate our expectations.

Hence, if there is no "instant gratification", we must execute a planned strategy to "run like thieves, with or without the loot!".

Trading Diversions!

Emotional Trading!

In real-time trading there are three emotional issues to consider:

1. Impatience to wait for a good setup.
2. The tendency of being "sucked in" by emotional swings out of short term price action.
   
3. The desire to predict market direction.

Missed Opportunity!

Opportunity, is not defined solely by the market and its movement. It is also a function of your trading signals and the ability of those signals to detect a positive expectancy in future returns.

If movement were opportunity, there could be no random price movement!.
http://traderfeed.blogspot.com

Your Own Trading Coach!

We can't control how markets move, so we can't control whether any single trade we make will be profitable or not. But we can control how we make trades: how we enter, how we size positions, how we exit, and how we contain losses.

Having rules about all of those helps us set specific goals about the process of trading, rather than about the outcome.

The goal of your learning is to trade well, just as the goal of a pitcher is to make a good pitch. If you do that often enough, you'll win your share of outings.
excerpted http://traderfeed.blogspot.com

Embrace Uncertainty!

Willingness to Experience Uncertainty

enables traders to follow

adaptive (trend-following) strategies.

Unwillingness to experience uncertainty

provides a bias toward

predictive (fundamental) strategies.

http://www.seykota.com