Webinar Topic 3
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1
OUR OBJECTIVES
p yyou g g into a typical yp To help gain an insight winning trader’s mentality To show you how your belief structure stands in the way of your being profitable To help you understand how your natural wiring is not ideal for the most consistent trading outcome
2
WHERE ARE YOU IN THIS?
Please take a moment to answer the following poll question: (poll)
3
YOUR EXPECTATIONS
p You have an expectation of how each outcome should be You believe that if you take a certain number of steps, you will achieve your expectation and will be rewarded What yyou perceive p is p possible and what yyou expect p out of the market is not what you are getting
This has nothing to do with the market. Your disappointment is the result of your attitude and false beliefs of the market 4
WHAT MOVES PRICES IN THE MARKET Buyers believe that prices will move up and can sell for higher prices Sellers believe that prices will move down and can buy back at lower prices There Th are only l TWO outcomes t off any given i trade. Do you believe this?
5
THE FORCES THAT MOVE THE MARKET
y 2 forces that move There are fundamentally the market:
Participants who believe that prices are too cheap and won’t go any lower Participants who believe that prices are too e pensi e and won’t expensive on’t go an any higher Each one of these participants…each trader executing a trade trade…is is a variable that has an effect on the product you are trading and on the final outcome of the trade 6
THE FORCES THAT MOVE THE MARKET Most people overlook a THIRD force. What is this 3rd force that can move the market?
It is the participants who have not yet taken a position and can enter at any time
7
MEASURING MARKET FORCES
Can we measure the first 2 forces?
Yes!
What are some of the tools to measure them?
Volume profiling Market Delta VWAP Volume histograms Bid/Ask Spreads Fibonacci Retracements Candlestick formations formations, price patterns patterns, etc 8
MEASURING MARKET FORCES
Can any of these tools measure the 3rd Force?
Absolutely not!
This 3rd Force is the unknown and is the greatest threat to your very next trade Again, each participant is also a variable and represents t a threat th t to t your very nextt trade t d
9
TRADING MISTAKES
What are some of the most common things traders do to sabotage their consistency?
You wait too long for a pre-defined area to do business and take the trade too late. You are waiting for “confirmation” You take the trade and take p profits very yq quickly y because yyou don’t want to lose You take the trade and it hits your stop (if you had one) and now you are too afraid to take the next trade. You are now waiting for “double confirmation confirmation” You take a loss and you fight back to make Mr. Market pay for what he did to you. You are now revenge trading You know what you have to do but are frozen by fear while you watch t h as someone else l ttakes k th the ttrade d you passed d on and d ffeell sick i k to your stomach as it gets to its targets You have been doing this for years and keep repeating the cycle of g one or more of these mistakes and then starting g over making 10
RESISTANCE TO THE UNKNOWN
Our minds are programmed since birth to operate in terms off cause and t d effect ff t Our entire education, career and daily life is based on an almost guaranteed outcome for the effort expended. E.g.. 2 2 = 4 or if I b 2+2 buy a titicket k t tto th the game, then th I will ill b be admitted and will have fun How does this tie in with the Market Forces described earlier? li ? IIs ttrading di th the right i ht b business i tto b be iin ffor th those who h want a guaranteed return on their effort? This is what makes trading what is possibly one of the mostt difficult diffi lt endeavors d especially i ll ffor th those coming i ffrom engineering, intellectual, medical and other highly educated backgrounds 11
RESISTANCE TO THE UNKNOWN g all of that, how does it help yyou to Knowing understand the difference between a consistently profitable trader and one who is not? The consistently profitable trader knows with every cell in his being that the outcome of th nextt trade the t d cannott be b known k It is key to distinguish between “thinking” that you don’t don t know and “knowing” knowing that you don’t don t know. This is an important distinction Now let’s look at our relationship p with losses….
12
A POLL ON LOSSES Let’s looks at the results of the p poll p posted on June 2nd, on my blog The question: q
“There is an outbreak of Asian Flu at your location. If nothing is done, they predict that 600 people will die Two courses of action have been suggested. die. suggested If program A is adopted, 200 people will be saved. If program B is adopted, there is a one-third probability that 600 people will be saved and a twothirds probability that no people will be saved. Which of the two programs do you favor?”
13
A POLL ON LOSSES
Poll Results:
Conclusion: Because lives were at stake, the great majority of those who took the poll are risk-averse in that they would gain by saving 200 and accept that 400 will perish. Program B gave us a chance of saving everyone but the probability was only 33%. Both Program A and Program B have the same outcome of only saving an average of 200 people If the wording had said “Program A guarantees 400 people will die” the majority would have chosen Program B. People are risk-seeking when thinking in terms of loss, but are risk-averse when they think of lives saved.
(302 samples)
14
YOUR INNER MONKEY Consider that based on that information, you are likely to give more room and more time to avoid closing a losing position You are also more likely to be risk-averse when you see a profit and will close the position for a small profit
15
THE TWO TWO-PRONGED PRONGED ENIGMA p So far,, we have explored the nature of the market by defining the various variables that are essentially unknown in their action We have also defined the nature of our highly educated and highly programmed minds that we have a propensity to risk-aversion with our profits and risk-seeking with losses Let’s now look at more specific loss patterns typical to trading
16
THOSE DARNED LOSSES
How many have in the past put on a trade without first defining and accepting the risk? (poll)
17
THOSE DARNED LOSSES y would an intelligent g Why trader who knows that there are unknown forces in the market ever consider putting on a trade without first defining th risk the i k or costt off finding fi di outt if the th trade t d would ld work? Have you defined what the market has to do for you to be wrong? Have you defined what the market has to feel like for you to be wrong? Have you defined how far you would allow it to test against you for you to be wrong?
18
THOSE DARNED LOSSES
What is the key reason why we would initiate and repeatt this thi behavior? b h i ? Answer: A typical yp trader will not trade until he has convinced himself that he is right! A typical trader will not trade unless he “knows” that there is no risk
Defining a stop-loss or the risk to a trade means that there has to be a conscious effort to prove oneself wrong Right? wrong. Given what we have learned about market Forces and our Inner Monkey, how true can “knowing” be??? 19
THOSE DARNED LOSSES
Let s shift gears for a second and look at Let’s another aspect of integrating losses within our beliefs:
Which one would cause you more pain? 1 1. 2.
Taking a stop-loss? stop loss? Losing an opportunity that you had?
(poll)
20
DEFLECTING RESPONSIBILITY
g an opportunity pp y truly y causes yyou more p If missing pain, then you are likely risk-seeking and absolutely need to have strong risk parameters in place. Missing an opportunity that you had and planned for is very painful because the blame can’t be shifted to the market If you prefer to have your stop-loss triggered, then your are risk-averse. Be cautious of conversations with yourself where you use the words “they they did this” this or “the market did that”. It is much easier and less painful to blame the market for your loss 21
THE PERFECT TRADE j y of the effort in Most traders spend a majority research to technically find a trade or setup that can get as close to guaranteeing a positive outcome as possible The reward of a positive outcome is the satisfaction of success, the release of E d hi and Endorphins d a generall ffeeling li off well-being ll b i To short-circuit this effort, most traders will gather as much information as possible to emotionally guarantee a positive outcome to the next trade in order to even put it on
22
THE PERFECT TRADE
g work with How does all of this information g gathering regards to determining the risk of any given trade? It works against the effort revealed in the last slide where an inconsistent trader will not likely put on a trade until he has convinced himself that he is right The logic g is: “I would not p put on the trade anyway y y unless I think I’m right. If I didn’t think I would be right, then I wouldn’t put on the trade anyway.” Th result: The lt F Forgett defining d fi i th the risk i k or using i a llogical i l or dynamic stop-loss (i.e. “I know that this will be a winner!”)) 23
PROBABILITIES AND OUTCOMES
g core A consistent trader has the following characteristics: 1.
2.
3.
4.
A probabilistic mentality that is a key to his or her approach h tto the th market k t An approach that is based on a reading at any given moment of what is the more likely dominant force as the market rotates An acceptance that the outcome of any given trade cannott be b known k until til th the ttrade d has h unwound d ititselflf An acceptance that the market, like the weather, will be tthe e final a co commander a de o of what at happens appe s next e t 24
PROBABILITIES AND OUTCOMES
Let s have a look at some simple truths existing Let’s in the market
You can take the exact same data,, same prices, p , same setup and same time of day and quantify it This data, to a less experienced trader, will result in the conclusion that the outcome should be identical Every moment in the market is a unique moment Why is this moment unique? ? o
Because we do not know if the same participants will be there and will do the same thing as last time 25
PROBABILITIES AND OUTCOMES
26
PROBABILITIES AND OUTCOMES
y trade can only y yyield one of two The outcome of any results: 1. 2 2.
The trade is a winner The trade is a loser
We do not know within any setup where the next winning g trade will show up p and where the next losing trade will show up. There is no way to know Once the trade has been put on, we know that this i a unique is i momentt and d we d do nott h have any control t l except to manage the trade according to our plan
27
PROBABILITIES AND OUTCOMES
If the outcome is only 50/50 (win/loss), then why bother b th trading t di att all? ll?
You might be mixing the distinction between the outcome of the next trade within a set of trades and the skew of th entire the ti sett off trades t d For example: You might have a setup that yields a 62% probability of winning over the long-run. Still, you do not k know where h th the 38% loss l will ill occur. It could ld h happen as a streak at the beginning or it could be randomly distributed across the sample or it could happen at the end It only takes one trader or variable to negate the outcome of your edge on this next trade Are we in agreement on this?
28
PROBABILITIES AND OUTCOMES
Let’s look at a couple of real-life examples of an exercise do. are the i that th t my traders t d d Here H th rules: l
A trader flips a coin. Heads is long. Tails is short. As soon as the outcome of the coin-toss is revealed,, the trader enters the market short or long at market The trader automatically enters a target of 4 ticks in ES and a stop p of 4 ticks in ES As soon as either the target or the stop-loss is triggered, the trader tosses the coin and does it again Minimum u sa sample p e must ust be 20 0 ttrades ades Let’s look at the outcome received from 2 out of 4 independent followers last week on Twitter
29
PROBABILITIES AND OUTCOMES
Eternum_ft: Eternum ft:
28 trades (14 short, 14 long – Randomly generated!) 20 losers 8 winners 28.8% Win Rate 8 Trades max losing streak Expectancy: <0.43> pts per trade
30
TRAD DE SU UMMA ARY F FOR ETERN NUM
31
TRAD DE SU UMMA ARY F FOR ETERN NUM
32
PROBABILITIES AND OUTCOMES
Kathy (used 6 tick target, 6 tick stop): 6-tick 6-tick
20 trades (10 short, 10 long – Randomly generated!) 13 losers 7 winners 35% Win Rate Expectancy: <0.5> pts per trade
33
HOW CAN WE USE THIS EXERCISE
The point of this exercise is simple:
The entry and direction of trade is undoubtedly random. How important is trade entry really? The random entry yielded an average of 33% win p percentage g on the strategy gy Without improving the entry at all, can this method be made profitable?
34
MAKING DUCK SOUP OUT OF DUCK # #*$% $%
With a little bit of study, we can turn this approach into a marginally system in i ll profitable fit bl or breakeven b k t i theory th We enter some risk and money management parameters to achieve this Here are some rules: 1. 2. 3. 4. 5.
Only 2% of account equity can be at risk We can only y trade this system y in a balanced market Our targets have to be at least 3 to 3.5 times our stop-loss We trade only in times of less directional bias (i.e. avoid first and last hour of cash market trading) All other rules remain the same
35
HOW MANY TRADES CAN THIS SYSTEM TAKE?
Given the limited account equity risked, how many trades can this system take before it has to stop trading?
36
HOW MANY TRADES CAN THIS SYSTEM TAKE? % of Account Risked per Trade assuming $100,000 account and d stop at $2,000 $2 000 off equity i remaining i i 450 400
390
350 300 250 194
200 150
129 97
100
77
64
54
50
47
42
38
34
32
30
26
26
24
22
21
20
19
0 1%
2%
3%
4%
5%
6%
7%
8%
9%
10% 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% No. of Trades
37
THE EDGE AND IMPROVING IT The Trader s Edge is simply a measure of the Trader’s “skew” or favorable probability of your setups Your edge can be a function of market understanding, research and a sample of trades large g enough g that will indicate that yyou will have a consistent positive outcome at the macro level Risk control and money management are key to drastically raising the outcome of your trading p earlier as shown in the random example
38
EMOTIONAL CAPITAL
Emotional capital is essentially the amount of stability and positive belief you have in your ability to achieve your objective Think of it as a bank account:
The more often you execute good trades (regardless of outcome), the more equity you deposit in your emotional capital account The more often you get emotional and lose control of your execution, the more debits you will have in that same account
If you make enough debits on our emotional capital account, we go into i t O Overdraft d ft Protection P t ti where h we experience i excessive i fear f with every trade Trading with fear results in hesitation, seeking more confirmation to guarantee winning trades trades, etc etc. Does that sound familiar? So let’s go back to the most common trading mistakes that we discussed earlier
39
THE MONKEY SYMPTOMS Mistake
Monkey Acting Out or Culprit
You wait too long for a pre-defined area to do business and take the trade too late. You are waiting for “confirmation”
Risk-Averse Monkey; Low emotional capital; Non-belief in random effect
You take the trade and take profits very quickly because you don’t want to lose
Risk Averse Monkey; Low emotional capital; Risk-Averse Non-belief in probability of setup
You take the trade and it hits your stop (if you had one) and now you are too afraid to take the next trade. You are now waiting for “double double confirmation” confirmation
Risk-Averse Monkey; Low emotional capital; Non-belief in random effect
You take a loss and you fight back to make Mr. Market pay for what he did to you. You are now revenge trading
Risk-Seeking Monkey; Ok emotional capital and about to debit; Non-belief in random effect
You k Y know what h t you have h to t do d but b t are frozen f b by fear f while you watch as someone else takes the trade you passed on and feel sick to your stomach as it gets to its targets
Risk-Averse Monkey; Low emotional capital, non belief in anything at all
You have been doing this for years and keep repeating the cycle of making one or more of these mistakes and then starting over
Risk-Seeking Monkey; Low emotional capital; non-belief in probability of setup 40
WHERE ARE YOU NOW?
Please take a moment to answer the following poll question again: (poll)
41
NEXT STEPS
Practice trading more mechanically. Know that you do not know. How do you achieve this?
I have given you the tools you need to form your hypothesis f Switch to a sim account for a few days and take every trade of a specific setup that shows up without fail and while knowing that the outcome of any trade is unknowable Define and accept either a fixed or dynamic stop-loss for every trade before taking it Trade a sample of at least 30 trades and then compute expectancy expectancy. Give your execution of every trade a grade of your choosing Keep a journal or log of your trades. Do something as simple as plotting or marking trades on a 3-minute chart at the end of each day for a couple of weeks. You will recognize a pattern Clear your o r screens of e everything er thing e except cept what hat you o use. se M My screens ha have e only onl what hat I need to support my trade decisions. This is a key step Your ultimate goal is to become ONE with the fact that every trade has an unknown outcome for EVERY market participant Never think in terms of “should”, “will” and “must”. Keep a flexible mind Don’t listen to the idea of “controlling” emotions. Don’t control them, use them to identify issues Never trade to make money. Trade to be a superior trader.
42
THE ROLE OF INTUITION
Left half of our brain is rational. It operates from prior information Right half of our brain is intuitive intuitive. It operates from our creative self self. Because the right half is creative, it essentially goes beyond the rational mind and taps into a belief system and the flow of the subject which you are focused on Once we have practiced our approach to trading enough (i (i.e. e Malcolm Gladwell’s “Outliers” of 10,000 hours of practice), then the intuitive mind begins to take over and to help us make decisions without the rational half being involved Achieving this state of being is what one sees when watching a great tennis player, golfer or artist perform his or her craft. The same can be achieved in trading How does it work? Nobody knows, but it essentially is caused by unleashing u eas g tthe e full u capac capacity ty o of ou our mind d to “see” see tthings gs tthat at a are e too subt subtle e for our rational mind to describe When someone is trading from this place, it is known as “trading in the zone” or “trading with the flow”
43
FINAL WORDS 1. 2. 3. 4. 5. 6. 7.
8.
We have looked at a small portion of the mental aspect of a consistent trader We have looked at the nature of the unknown aspect of trading We have looked at the nature of our mind as affected by our natural aversion to risk as well as the effect of our education and programming We have looked at the nature of losing and losses on our decisions and emotional capital We have looked at the relative unimportance of trade entry when compared to trade management and risk management We have discussed the random effect on your very next trade We have discussed some basic steps that can be taken to improve your mental readiness to take on the next trade and to accept the wins or losses We have looked at the role of intuition “You control how you trade; the market controls how or when you will get paid” – Brett Steenbarger, The Daily Trading Coach 44
45
OUR OBJECTIVES
p yyou g g into a typical yp To help gain an insight winning trader’s mentality To show you how your belief structure stands in the way of your being profitable To help you understand how your natural wiring is not ideal for the most consistent trading outcome
2
WHERE ARE YOU IN THIS?
Please take a moment to answer the following poll question: (poll)
3
YOUR EXPECTATIONS
p You have an expectation of how each outcome should be You believe that if you take a certain number of steps, you will achieve your expectation and will be rewarded What yyou perceive p is p possible and what yyou expect p out of the market is not what you are getting
This has nothing to do with the market. Your disappointment is the result of your attitude and false beliefs of the market 4
WHAT MOVES PRICES IN THE MARKET Buyers believe that prices will move up and can sell for higher prices Sellers believe that prices will move down and can buy back at lower prices There Th are only l TWO outcomes t off any given i trade. Do you believe this?
5
THE FORCES THAT MOVE THE MARKET
y 2 forces that move There are fundamentally the market:
Participants who believe that prices are too cheap and won’t go any lower Participants who believe that prices are too e pensi e and won’t expensive on’t go an any higher Each one of these participants…each trader executing a trade trade…is is a variable that has an effect on the product you are trading and on the final outcome of the trade 6
THE FORCES THAT MOVE THE MARKET Most people overlook a THIRD force. What is this 3rd force that can move the market?
It is the participants who have not yet taken a position and can enter at any time
7
MEASURING MARKET FORCES
Can we measure the first 2 forces?
Yes!
What are some of the tools to measure them?
Volume profiling Market Delta VWAP Volume histograms Bid/Ask Spreads Fibonacci Retracements Candlestick formations formations, price patterns patterns, etc 8
MEASURING MARKET FORCES
Can any of these tools measure the 3rd Force?
Absolutely not!
This 3rd Force is the unknown and is the greatest threat to your very next trade Again, each participant is also a variable and represents t a threat th t to t your very nextt trade t d
9
TRADING MISTAKES
What are some of the most common things traders do to sabotage their consistency?
You wait too long for a pre-defined area to do business and take the trade too late. You are waiting for “confirmation” You take the trade and take p profits very yq quickly y because yyou don’t want to lose You take the trade and it hits your stop (if you had one) and now you are too afraid to take the next trade. You are now waiting for “double confirmation confirmation” You take a loss and you fight back to make Mr. Market pay for what he did to you. You are now revenge trading You know what you have to do but are frozen by fear while you watch t h as someone else l ttakes k th the ttrade d you passed d on and d ffeell sick i k to your stomach as it gets to its targets You have been doing this for years and keep repeating the cycle of g one or more of these mistakes and then starting g over making 10
RESISTANCE TO THE UNKNOWN
Our minds are programmed since birth to operate in terms off cause and t d effect ff t Our entire education, career and daily life is based on an almost guaranteed outcome for the effort expended. E.g.. 2 2 = 4 or if I b 2+2 buy a titicket k t tto th the game, then th I will ill b be admitted and will have fun How does this tie in with the Market Forces described earlier? li ? IIs ttrading di th the right i ht b business i tto b be iin ffor th those who h want a guaranteed return on their effort? This is what makes trading what is possibly one of the mostt difficult diffi lt endeavors d especially i ll ffor th those coming i ffrom engineering, intellectual, medical and other highly educated backgrounds 11
RESISTANCE TO THE UNKNOWN g all of that, how does it help yyou to Knowing understand the difference between a consistently profitable trader and one who is not? The consistently profitable trader knows with every cell in his being that the outcome of th nextt trade the t d cannott be b known k It is key to distinguish between “thinking” that you don’t don t know and “knowing” knowing that you don’t don t know. This is an important distinction Now let’s look at our relationship p with losses….
12
A POLL ON LOSSES Let’s looks at the results of the p poll p posted on June 2nd, on my blog The question: q
“There is an outbreak of Asian Flu at your location. If nothing is done, they predict that 600 people will die Two courses of action have been suggested. die. suggested If program A is adopted, 200 people will be saved. If program B is adopted, there is a one-third probability that 600 people will be saved and a twothirds probability that no people will be saved. Which of the two programs do you favor?”
13
A POLL ON LOSSES
Poll Results:
Conclusion: Because lives were at stake, the great majority of those who took the poll are risk-averse in that they would gain by saving 200 and accept that 400 will perish. Program B gave us a chance of saving everyone but the probability was only 33%. Both Program A and Program B have the same outcome of only saving an average of 200 people If the wording had said “Program A guarantees 400 people will die” the majority would have chosen Program B. People are risk-seeking when thinking in terms of loss, but are risk-averse when they think of lives saved.
(302 samples)
14
YOUR INNER MONKEY Consider that based on that information, you are likely to give more room and more time to avoid closing a losing position You are also more likely to be risk-averse when you see a profit and will close the position for a small profit
15
THE TWO TWO-PRONGED PRONGED ENIGMA p So far,, we have explored the nature of the market by defining the various variables that are essentially unknown in their action We have also defined the nature of our highly educated and highly programmed minds that we have a propensity to risk-aversion with our profits and risk-seeking with losses Let’s now look at more specific loss patterns typical to trading
16
THOSE DARNED LOSSES
How many have in the past put on a trade without first defining and accepting the risk? (poll)
17
THOSE DARNED LOSSES y would an intelligent g Why trader who knows that there are unknown forces in the market ever consider putting on a trade without first defining th risk the i k or costt off finding fi di outt if the th trade t d would ld work? Have you defined what the market has to do for you to be wrong? Have you defined what the market has to feel like for you to be wrong? Have you defined how far you would allow it to test against you for you to be wrong?
18
THOSE DARNED LOSSES
What is the key reason why we would initiate and repeatt this thi behavior? b h i ? Answer: A typical yp trader will not trade until he has convinced himself that he is right! A typical trader will not trade unless he “knows” that there is no risk
Defining a stop-loss or the risk to a trade means that there has to be a conscious effort to prove oneself wrong Right? wrong. Given what we have learned about market Forces and our Inner Monkey, how true can “knowing” be??? 19
THOSE DARNED LOSSES
Let s shift gears for a second and look at Let’s another aspect of integrating losses within our beliefs:
Which one would cause you more pain? 1 1. 2.
Taking a stop-loss? stop loss? Losing an opportunity that you had?
(poll)
20
DEFLECTING RESPONSIBILITY
g an opportunity pp y truly y causes yyou more p If missing pain, then you are likely risk-seeking and absolutely need to have strong risk parameters in place. Missing an opportunity that you had and planned for is very painful because the blame can’t be shifted to the market If you prefer to have your stop-loss triggered, then your are risk-averse. Be cautious of conversations with yourself where you use the words “they they did this” this or “the market did that”. It is much easier and less painful to blame the market for your loss 21
THE PERFECT TRADE j y of the effort in Most traders spend a majority research to technically find a trade or setup that can get as close to guaranteeing a positive outcome as possible The reward of a positive outcome is the satisfaction of success, the release of E d hi and Endorphins d a generall ffeeling li off well-being ll b i To short-circuit this effort, most traders will gather as much information as possible to emotionally guarantee a positive outcome to the next trade in order to even put it on
22
THE PERFECT TRADE
g work with How does all of this information g gathering regards to determining the risk of any given trade? It works against the effort revealed in the last slide where an inconsistent trader will not likely put on a trade until he has convinced himself that he is right The logic g is: “I would not p put on the trade anyway y y unless I think I’m right. If I didn’t think I would be right, then I wouldn’t put on the trade anyway.” Th result: The lt F Forgett defining d fi i th the risk i k or using i a llogical i l or dynamic stop-loss (i.e. “I know that this will be a winner!”)) 23
PROBABILITIES AND OUTCOMES
g core A consistent trader has the following characteristics: 1.
2.
3.
4.
A probabilistic mentality that is a key to his or her approach h tto the th market k t An approach that is based on a reading at any given moment of what is the more likely dominant force as the market rotates An acceptance that the outcome of any given trade cannott be b known k until til th the ttrade d has h unwound d ititselflf An acceptance that the market, like the weather, will be tthe e final a co commander a de o of what at happens appe s next e t 24
PROBABILITIES AND OUTCOMES
Let s have a look at some simple truths existing Let’s in the market
You can take the exact same data,, same prices, p , same setup and same time of day and quantify it This data, to a less experienced trader, will result in the conclusion that the outcome should be identical Every moment in the market is a unique moment Why is this moment unique? ? o
Because we do not know if the same participants will be there and will do the same thing as last time 25
PROBABILITIES AND OUTCOMES
26
PROBABILITIES AND OUTCOMES
y trade can only y yyield one of two The outcome of any results: 1. 2 2.
The trade is a winner The trade is a loser
We do not know within any setup where the next winning g trade will show up p and where the next losing trade will show up. There is no way to know Once the trade has been put on, we know that this i a unique is i momentt and d we d do nott h have any control t l except to manage the trade according to our plan
27
PROBABILITIES AND OUTCOMES
If the outcome is only 50/50 (win/loss), then why bother b th trading t di att all? ll?
You might be mixing the distinction between the outcome of the next trade within a set of trades and the skew of th entire the ti sett off trades t d For example: You might have a setup that yields a 62% probability of winning over the long-run. Still, you do not k know where h th the 38% loss l will ill occur. It could ld h happen as a streak at the beginning or it could be randomly distributed across the sample or it could happen at the end It only takes one trader or variable to negate the outcome of your edge on this next trade Are we in agreement on this?
28
PROBABILITIES AND OUTCOMES
Let’s look at a couple of real-life examples of an exercise do. are the i that th t my traders t d d Here H th rules: l
A trader flips a coin. Heads is long. Tails is short. As soon as the outcome of the coin-toss is revealed,, the trader enters the market short or long at market The trader automatically enters a target of 4 ticks in ES and a stop p of 4 ticks in ES As soon as either the target or the stop-loss is triggered, the trader tosses the coin and does it again Minimum u sa sample p e must ust be 20 0 ttrades ades Let’s look at the outcome received from 2 out of 4 independent followers last week on Twitter
29
PROBABILITIES AND OUTCOMES
Eternum_ft: Eternum ft:
28 trades (14 short, 14 long – Randomly generated!) 20 losers 8 winners 28.8% Win Rate 8 Trades max losing streak Expectancy: <0.43> pts per trade
30
TRAD DE SU UMMA ARY F FOR ETERN NUM
31
TRAD DE SU UMMA ARY F FOR ETERN NUM
32
PROBABILITIES AND OUTCOMES
Kathy (used 6 tick target, 6 tick stop): 6-tick 6-tick
20 trades (10 short, 10 long – Randomly generated!) 13 losers 7 winners 35% Win Rate Expectancy: <0.5> pts per trade
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HOW CAN WE USE THIS EXERCISE
The point of this exercise is simple:
The entry and direction of trade is undoubtedly random. How important is trade entry really? The random entry yielded an average of 33% win p percentage g on the strategy gy Without improving the entry at all, can this method be made profitable?
34
MAKING DUCK SOUP OUT OF DUCK # #*$% $%
With a little bit of study, we can turn this approach into a marginally system in i ll profitable fit bl or breakeven b k t i theory th We enter some risk and money management parameters to achieve this Here are some rules: 1. 2. 3. 4. 5.
Only 2% of account equity can be at risk We can only y trade this system y in a balanced market Our targets have to be at least 3 to 3.5 times our stop-loss We trade only in times of less directional bias (i.e. avoid first and last hour of cash market trading) All other rules remain the same
35
HOW MANY TRADES CAN THIS SYSTEM TAKE?
Given the limited account equity risked, how many trades can this system take before it has to stop trading?
36
HOW MANY TRADES CAN THIS SYSTEM TAKE? % of Account Risked per Trade assuming $100,000 account and d stop at $2,000 $2 000 off equity i remaining i i 450 400
390
350 300 250 194
200 150
129 97
100
77
64
54
50
47
42
38
34
32
30
26
26
24
22
21
20
19
0 1%
2%
3%
4%
5%
6%
7%
8%
9%
10% 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% No. of Trades
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THE EDGE AND IMPROVING IT The Trader s Edge is simply a measure of the Trader’s “skew” or favorable probability of your setups Your edge can be a function of market understanding, research and a sample of trades large g enough g that will indicate that yyou will have a consistent positive outcome at the macro level Risk control and money management are key to drastically raising the outcome of your trading p earlier as shown in the random example
38
EMOTIONAL CAPITAL
Emotional capital is essentially the amount of stability and positive belief you have in your ability to achieve your objective Think of it as a bank account:
The more often you execute good trades (regardless of outcome), the more equity you deposit in your emotional capital account The more often you get emotional and lose control of your execution, the more debits you will have in that same account
If you make enough debits on our emotional capital account, we go into i t O Overdraft d ft Protection P t ti where h we experience i excessive i fear f with every trade Trading with fear results in hesitation, seeking more confirmation to guarantee winning trades trades, etc etc. Does that sound familiar? So let’s go back to the most common trading mistakes that we discussed earlier
39
THE MONKEY SYMPTOMS Mistake
Monkey Acting Out or Culprit
You wait too long for a pre-defined area to do business and take the trade too late. You are waiting for “confirmation”
Risk-Averse Monkey; Low emotional capital; Non-belief in random effect
You take the trade and take profits very quickly because you don’t want to lose
Risk Averse Monkey; Low emotional capital; Risk-Averse Non-belief in probability of setup
You take the trade and it hits your stop (if you had one) and now you are too afraid to take the next trade. You are now waiting for “double double confirmation” confirmation
Risk-Averse Monkey; Low emotional capital; Non-belief in random effect
You take a loss and you fight back to make Mr. Market pay for what he did to you. You are now revenge trading
Risk-Seeking Monkey; Ok emotional capital and about to debit; Non-belief in random effect
You k Y know what h t you have h to t do d but b t are frozen f b by fear f while you watch as someone else takes the trade you passed on and feel sick to your stomach as it gets to its targets
Risk-Averse Monkey; Low emotional capital, non belief in anything at all
You have been doing this for years and keep repeating the cycle of making one or more of these mistakes and then starting over
Risk-Seeking Monkey; Low emotional capital; non-belief in probability of setup 40
WHERE ARE YOU NOW?
Please take a moment to answer the following poll question again: (poll)
41
NEXT STEPS
Practice trading more mechanically. Know that you do not know. How do you achieve this?
I have given you the tools you need to form your hypothesis f Switch to a sim account for a few days and take every trade of a specific setup that shows up without fail and while knowing that the outcome of any trade is unknowable Define and accept either a fixed or dynamic stop-loss for every trade before taking it Trade a sample of at least 30 trades and then compute expectancy expectancy. Give your execution of every trade a grade of your choosing Keep a journal or log of your trades. Do something as simple as plotting or marking trades on a 3-minute chart at the end of each day for a couple of weeks. You will recognize a pattern Clear your o r screens of e everything er thing e except cept what hat you o use. se M My screens ha have e only onl what hat I need to support my trade decisions. This is a key step Your ultimate goal is to become ONE with the fact that every trade has an unknown outcome for EVERY market participant Never think in terms of “should”, “will” and “must”. Keep a flexible mind Don’t listen to the idea of “controlling” emotions. Don’t control them, use them to identify issues Never trade to make money. Trade to be a superior trader.
42
THE ROLE OF INTUITION
Left half of our brain is rational. It operates from prior information Right half of our brain is intuitive intuitive. It operates from our creative self self. Because the right half is creative, it essentially goes beyond the rational mind and taps into a belief system and the flow of the subject which you are focused on Once we have practiced our approach to trading enough (i (i.e. e Malcolm Gladwell’s “Outliers” of 10,000 hours of practice), then the intuitive mind begins to take over and to help us make decisions without the rational half being involved Achieving this state of being is what one sees when watching a great tennis player, golfer or artist perform his or her craft. The same can be achieved in trading How does it work? Nobody knows, but it essentially is caused by unleashing u eas g tthe e full u capac capacity ty o of ou our mind d to “see” see tthings gs tthat at a are e too subt subtle e for our rational mind to describe When someone is trading from this place, it is known as “trading in the zone” or “trading with the flow”
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FINAL WORDS 1. 2. 3. 4. 5. 6. 7.
8.
We have looked at a small portion of the mental aspect of a consistent trader We have looked at the nature of the unknown aspect of trading We have looked at the nature of our mind as affected by our natural aversion to risk as well as the effect of our education and programming We have looked at the nature of losing and losses on our decisions and emotional capital We have looked at the relative unimportance of trade entry when compared to trade management and risk management We have discussed the random effect on your very next trade We have discussed some basic steps that can be taken to improve your mental readiness to take on the next trade and to accept the wins or losses We have looked at the role of intuition “You control how you trade; the market controls how or when you will get paid” – Brett Steenbarger, The Daily Trading Coach 44
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