- The potential of initial and temporary success only exists in trading. You can’t just call yourself a brain surgeon and get lucky while messing around in someone’s head. And just stepping on stage and trying to give a violin concert if you have never touched a violin before won’t end too well either.
- Right, wrong, win and lose are inappropriate terms for describing the participation in the markets. In 20/20 hindsight, decisions might be good or bad but not right or wrong. With regards to the markets, only expressed opinions can be right or wrong. Market positions are either profitable or unprofitable.
- There are as many ways to make money in the markets as there are participants. But there are only very few ways to lose.
- A light-bulb manufacturer understands that 2 out of 10 bulbs will not work; a fruit seller knows that some apples will be foul. Those losses are expected. In trading, we don’t expect to lose when we enter a trade. Unexpected losses are hard to deal with. Acknowledging that losses are part of the game and accepting the losses are two very different things.
- In trading, losses are treated as mistakes and from early on, we have been taught that mistakes are bad and have to be avoided.
- If you know exactly how much you are going to win, but don’t know how much you can lose, you are denying losses.
- Trading is an activity without a beginning and an end. In an activity without an end, you can always make decisions and change your decisions based on the current situation. A football game, a roulette spin or blackjack have defined beginnings and endings; after the game is over, you can’t change anything. You have to accept the outcome. It’s not open for interpretation; you (your team) have lost or won. In trading, the “game” (activity) never ends and your trade (potentially) never ends. Because your trade doesn’t end, your loss is never final and it could always turn around.
- Rules are hard and fast. Tools have some flexibility. Fools neither have rules nor tools.
- A scenario might have been an acceptable trade based on someone else’s rules. Profitable opportunities will occur that you won’t participate in. Your rules will only enable you to engage in some of the millions of opportunities.
- You can’t calculate the probability of having a winner. You can only calculate how much you are going to lose. All you can do is manage your losses and not predict your profits.
- People usually pick the exit point as a function of their entry point and it’s usually some arbitrary Dollar amount.
- People rationalize a trade idea by expressing the trade in terms of the money odd’s fallacy – “it’s a three to one reward-risk ratio! I’ll risk $500 to make $1500”. The reward-risk ratio gives no information about the likelihood of winning a trade.
- People who ask, “Why is the market up or down?” don’t want to know why. They only want to hear the reasons that justify their losing position.
- The last moment of objectivity for the roulette player is the moment before he places his bet and the wheels starts spinning. After that, he can’t do anything anymore to lose more money. For the market participant, the last moment of objectivity is the moment before he places his trade. But after that, he can still do a lot to lose more money. That’s why all your decisions and plans have to be made pre-trade.
Archives of “expected value” tag
rss
The secret to trading success- U
You are the weakest part of your system. It is a defeatist statement. It makes your expectation to fail easier to accomplish and more importantly it makes failure easier to handle. It shifts the pressure away from you and unto fate.
Would you fly on an airline if their motto was “Our pilots are the weakest part.” I do not think so. You are your system. Even if your system is automated you added the inputs, parameters.
Taking responsibility for your action is not easy. Taking control of the outcomes of trading or life is a huge responsibility. You will have moments of weakness, but you are not weak. The market does not go straight up and either does the road to success.
A Review: “Two Centuries of Trend Following”
The paper “Two Centuries of Trend Following” by Lemperiere, Derenble, Seager, et al of Capital Fund Management purports to show that trend following has been profitable, over a wide range of markets, consistently over 200 years. It deserves to be reviewed as it represents a case study of the statistical practices, and armchair explanations that are sometimes used to justify a system that in the most recent five year period has lost its mojo. Rocky has asked me to review it.
The amazing thing is that the authors seem to know how to compute hyperbolic tangent regressions, and compute the duration of a drawdown given a sharpe ratio, yet they seem completely unaware of the problem of multicollinearity, overlapping observations, and lack of independent observations.
In a nutshell, they compute hundreds of thousands of means, and they combine them and measure how far away from randomness they are. Recall that the average of two random observations is about 0.7 times as variable as one observations. The average of 100,000 observations is about 1/320 as variable as 1 observation. (more…)
Secret to trading success: You
“You are the weakest part of your system”. That is a defeatist statement and completely untrue. It makes your expectation to fail easier to accomplish and more importantly it makes failure easier to handle. It shifts the pressure away from you and unto fate.
Would you fly on an airline if their motto was “Our pilots are the weakest part.” I do not think so. You are your system. Even if your system is automated you added the inputs, parameters.
Taking responsibility for your action is not easy. Taking control of the outcomes of trading or life is a huge responsibility. You will have moments of weakness, but you are not weak. The market does not go straight up and either does the road to success.
Uncertain Outcome, Consistent Result
Every trader knows trading is a probability game. However, very few can internalize and live by the true meaning of what it means to be a probability game.
Mark Douglas, the author of “Trading in the Zone”, explains it well. Someone who masters the probability game produces uncertain outcome but consistent result. The best example to illustrate this concept is the casino business. The casino holds on the average 4.5% probability advantage over the player. It does not know whether the next hand will be a winner or a loser against the player, but the casino is certain that they always win given enough bets. Therefore casinos do not care if a player is going through a winning streak, as long as he is not cheating.
That’s exactly how traders need to think about his trades. Market is random. Anything can happen to the current trade. A trader can increase his probability of winning either through fundamental or technical analysis but the best analysis can never produce a 100% certainty. In reality, the highest win rate that the best analysis can produce is far from 100%. However, as long as the trader has a trading plan that can produce positive expected value, he can expect consistent result over a reasonably large number of trades, just like the casino. (more…)
On Being the Right Size
I found this 1926 paper “On Being the Right Size” by J. B. S. Haldane quite fascinating.
To the mouse and any smaller animal it presents practically no dangers. You can drop a mouse down a thousand-yard mine shaft; and, on arriving at the bottom it gets a slight shock and walks away, provided that the ground is fairly soft. A rat is killed, a man is broken, a horse splashes.
That reminds me of Billy Eckhardt’s comments on bet size…
If you plot system performance against bet size, you obtain a curve in the shape of a rightward-facing cartoon whale, going up in a straight line before dropping dramatically.
He said: “Trading size is one aspect you don’t want to optimize: the optimum comes just before the precipice. You want to be at the left of the optimal point, in the high zone of the straight curve.” (more…)