Archives of “mathematical finance” tag

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Chasing a Trade and The Power of Regret

  
  Education
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Everyone knows that chasing price is usually not beneficial, we either end up catching the move too late, or we get poor trade location, which makes it more difficult to manage the trade.

However, there are other forms of chasing that are just as common, maybe more common, and just as counter-productive. 

Traders who are not profitable are often too quick to chase after new set-ups and indicators, or a different chat room, if that’s your thing.  Obviously, we need to have a trading edge, whether it is from the statistical perspective of a positive expectancy, or simply the confidence in a particular discretionary strategy such as tape reading, following order flow, market profile, etc.

Chasing a trade is the fear of missing out. The fear of missing out is associated with various emotions, including regret. There’s a lot of talk about fear and greed in trading, but the power of regret is often overlooked. Some of my own worst trades, and those of my clients, often have a ‘regret from missing a prior opportunity’ component. When I finally finish my book on the psychology of financial risk taking, I will include much about this overlooked but very powerful emotion.

Somewhat related to chasing a trade, is impulse trading.  They both have in common the underlying feeling of the fear of missing out.  It’s tempting for me to talk about impulse trading here, but it really deserves its own piece.

How did we end up with two, different definitions of risk?

  
  Education
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When I say “risk” and you say “risk,” chances are high we don’t mean the same thing.

The finance industry defines risk as something measurable. It is variability within a set of known limits. You may have heard it referred to as standard deviation or even volatility. Ultimately, it represents how much an investment wiggles over time.

I’m an adviser who talks to humans. I also happen to be human. From my experience, I know humans outside the financial world define risk differently. In everyday life, we tend to think of risk as uncertainty, or what is left over after we have thought of everything else.

With uncertainty comes variability within a set of unknown limits. It’s the stuff that comes out of left field, like Nassim Nicholas Taleb’s black swan events. Because we can’t measure uncertainty with any sort of accuracy, we think of risk as something outside our control. We often connect it to things like running out of money in retirement or ending up in a car crash.

But how did we end up with two such completely different definitions of the same thing? My research points to an economist named Frank Knight and his book “Risk, Uncertainty and Profit.”

(more…)

Traders Should Control These 14 Emotions

  
  Education
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14-POINTS
 

Anger- Revenge trading

Fear- Inability to take an entry or hold a winner in a trend.

Disgust- Can lead to loss of a traders confidence.

Happiness- Surprisingly can lead to trading too big and taking on too many positions.

Sadness- Can lead to having difficulty taking the next trade entry or cutting a loss.

Surprise- Can many times lead to making decisions based on emotions and abandoning a trading plan. (more…)

15 Points For Traders

  
  Education
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1. Don’t be a tradeaholic
Agreed
2. You trade to make money – not for fun, games, or to escape boredom
Definitely
3. Never add to a bad trade
If you have a specific strategy which includes adding to a trade which has gone against you, that’s one thing. Just “averaging down” is usually a bad play.
4. Once you have a profit on a trade, never let it turn into a loss
This can be a really good plan for psychology purposes, but it may or may not be appropriate for the type of strategy/system you employ.
5. No hoping, no wishing, no would’ve, no opinions, no should’ve
It’s hard not to second-guess, and reviewing thinking after the fact is part of the learning process, but never do it in trade.
6. Don’t be a one way trader – be flexible, opportunities on both sides
More opportunities doesn’t necessarily mean better trading. Some systems, markets, and/or traders are just better one-way only.
7. Know your risk on each trade. Trade with stops to limit losses
Definitely yes on the first part. The second part is up for debate in some ways.
8. Look for 3-1 profit objective trade
Totally disagree. This can’t be taken in isolation. You can have fantastic results with a smaller R/R ratio. It depends on your system’s or method’s win %.
9. When initiating a trade, always get your price (use a limit order)
Depends on your system. (more…)

10 Ways to Move From Peril to Profits

  
  Education
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  1. The first question to ask in any option trade is how much of my capital could I lose in the worst case scenario not how much can I make.
  2. Long options are tools that can be used to create asymmetric trades with a built in downside and unlimited upside.
  3. Short options should only be sold when the probabilities are deeply in your favor that they will expire worthless, also a small hedge can pay for itself in the long run.
  4. Understand that in long options you have to overcome the time priced into the premium to be profitable even if you are right on the direction of the move.
  5. Long  weekly deep-in-the-money options can be used like stock with much less out lay of capital.
  6. The reason that deeper in the money options have so little time and volatility priced in is becasue you are ensuring someones profits in that stock. That is where the risk is:intrinsic value, and that risk is on the buyer.
  7. When you buy out-of-the-money options understand that you must be right about direction, time period of move, and amount of move to make money. Also understand this is already priced in.
  8. When trading a high volatility event that price move will be priced into the option, after the event the option price will remove that volatility value and the option value will collapse. You can only make money through those events with options if the increase in intrinsic value increases enough to replace the vega value that comes out.
  9. Only trade in options with high volume so you do not lose a large amount of money on the bid/ask spread when entering and exiting trades.
  10. When used correctly options can be tools for managing risk, used incorrectly they can blow up your account. I suggest never risking more than 1% of your trading capital on any one option trade.

 

David Halsey,Trading the Measured Move -Book Review

  
  Education
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David Halsey throws out the old notion of a measured move: that you copy an AB move up (or down) and paste it on a retracement low (or high) of C to get your price target D. In Trading the Measured Move: A Path to Trading Success in a World of Algos and High Frequency Trading(Wiley, 2014) he substitutes Fibonacci levels.

He uses three trade setups: the traditional 50% retracement measured move (MM), the extension 50% MM, and the 61.8% failure. When a trade is entered, its target is 123% from a swing high or low (and sometimes from a breakout) that is followed by a retracement (50% in the traditional setup). That is, the target is AB + 23%. Halsey shows both successful and failed MM trades on charts—unfortunately usually grey bars on a black background, which makes them hard to decipher.

The measured move trade setups are not stand-alones. Halsey discusses the use of multiple time frames, seasonality, NYSE tools, tick extremes and divergences, and gaps. He also discusses how to manage positions and take profits, advanced (actually, pretty basic) risk management, trading psychology, and having a trading plan and journal. (more…)

10 Quotes by Mark Douglas

  
  Education
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reading“I know it may sound strange to many readers, but there is an inverse relationship between analysis and trading results. More analysis or being able to make distinctions in the market’s behavior will not produce better trading results. There are many traders who find themselves caught in this exasperating loop, thinking that more or better analysis is going to give them the confidence they need to do what needs to be done to achieve success. It’s what I call a trading paradox that most traders find difficult, if not impossible to reconcile, until they realize you can’t use analysis to overcome fear of being wrong or losing money. It just doesn’t work!”
-Mark Douglas

“There is a random distribution between wins and losses for any given set of variables that defines an edge. In other words, based on the past performance of your edge, you may know that out of the next 20 trades, 12 will be winners and 8 will be losers. What you don’t know is the sequence of wins and losses or how much money the market is going to make available on the winning trades. This truth makes trading a probability or numbers game. When you really believe that trading is simply a probability game, concepts like “right” and “wrong” or “win” and “lose” no longer have the same significance. As a result, your expectations will be in harmony with the possibilities.”
-Mark Douglas

The less I cared about whether or not I was wrong, the clearer
things became, making it much easier to move in and out of positions,
cutting my losses short to make myself mentally available to take the next opportunity.
– Mark Douglas (more…)

10 Questions for Trend Followers ,Yes Just Answer Them

  
  Education
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Now, let’s get practical. Answer the following five questions, and you have a trend following trading system:

1. What market do you buy or sell at any time?
2. How much of a market do you buy or sell at any time?
3. When do you buy or sell a market?
4. When do you get out of a losing position?
5. When do you get out of a winning position?

Said another way (Bill Eckhardt inspired):

1. What is the state of the market?
2. What is the volatility of the market?
3. What is the equity being traded?
4. What is the system or the trading orientation?
5. What is the risk aversion of the trader or client?

You want to be black or white with this. You do not want gray. If you can accept that mentality, you have got it.

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