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Trading Mathematics and Trend Following

  
  Education
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Some quick points, to be making money, Profit Factor must be greater than 1.

  • Profit Factor (PF)
  • = Gross Gains / Gross Losses
  • = (Average win * number of wins) / (Average loss * number of losses)
  • = R * w / (1-w)
    • where R = Average win / Average loss
    • w = win rate, i.e. % number of winners compared to total number of trades

Re-arranging, we have

  • w = PF / (PF + R)
  • R = PF * (1 – w) / w

Sample numbers showing the minimum R required to break-even (i.e. PF = 1, assuming no transaction costs) for varying win rates.

  • w = 90% >> R = 0.11
  • w = 80% >> R = 0.25
  • w = 70% >> R = 0.43
  • w = 60% >> R = 0.67
  • w = 50% >> R = 1
  • w = 40% >> R = 1.5
  • w = 30% >> R = 2.33
  • w = 20% >> R = 4
  • w = 10% >> R = 9

The style of trading strongly influences the win rate and R (average winner / average loser). For example, (more…)

10 Friends & 10 Enemies of Traders

  
  Education
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A Trader’s 10 Best Friends

  1. Studying the markets to understand what works. $Study
  2. You are comfortable with uncertainty. ????
  3. Being optimistic about winning in the long term. #Winning
  4. You manage risk very carefully on each trade. #RiskofRuin
  5. Thinking in probabilities and asymmetrical trades. #RiskReward
  6. Following your trading plan. #Discipline
  7. Accepting losses. #StopLoss
  8. Letting winners run. #TrendFollowing
  9. A plan on exactly how you will trade. #TradingPlan
  10. A robust trading system. #EDGE

A Trader’s 10 Worst Enemies

  1. Scared to enter a trade.#Fear
  2. Feeling the need to be right on every trade. #Pride
  3. Entering a trade too late or taking profits too soon. #Impatience (more…)

Volatile vs. Smooth

  
  Education
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“Conventional economic reasoning says that if two stocks have similar expected future cash flows and similar dependence on the market, we prefer the one that is less volatile. But might we not see some advantage to stock in volatile company A, which has survived many crises, over stock in safe, untested company B? Perhaps A’s stresses have allowed evolution of the characteristics that will succeed in the future, whereas B is narrowly positioned for the conditions of the past. In the future, perhaps A’s volatility will allow it to move faster into opportunities and away from dead ends, and to evolve as conditions change.”

– Aaron Brown, Red-Blooded Risk

Why does academia assume lower volatility is better?
How many real world instances have you seen confirming that more volatile = more robust, while smooth = over managed, artificial, and possibly brittle?
What are some of the advantages of embracing volatility — managing it versus shunning it?

Traders Should Have These 5 Qualities

  
  Education
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1) Capacity for Prudent Risk-Taking – Successful young traders are neither impulsive nor risk-averse. They are not afraid to go after markets aggressively when they perceive opportunity;
2) Capacity for Rule Governance – Successful young traders have the self-control needed to follow rules in the heat of battle, including rules of position sizing and risk management;
3) Capacity for Sustained Effort – Successful young traders can be identified by the productive time they spend on trading–research, preparation, work on themselves–outside of market hours;
4) Capacity for Emotional Resilience – All young traders will lose money early in their development and experience multiple frustrations. The successful ones will not be quick to lose self-confidence and motivation in the face of loss and frustration;
5) Capacity for Sound Reasoning – Successful young traders exhibit an ability to make sense of markets by synthesizing data and generating market and trading views. They display patience in collecting information and do not jump to conclusions based on superficial reasoning or limited data.

2 -Risk Quotes For Traders

  
  Education
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 Risk ManagementYou are the biggest risk. Yes, that’s right you. All of your talk of discipline, preparation, planning, all of the hours of screentime, all of the chats with trader friends–all of that isn’t worth much if you are don’t follow through and do the right thing. If you aren’t disciplined every moment of every trading day, you are not a disciplined trader. The market environment is harder than you can imagine, and it will challenge you to the very limits of human endurance. Spend a lot of time thinking about the most critical part of your trading system: you, yourself.

 Plan for risks outside the market. Everyone, from the institutional scale to the individual trader, will have outside influences challenge their market activities. Institutionally, regulatory changes and developments in market structure can dramatically change the playing field. Your investors will make mistakes–becoming fearful and exuberant at exactly the wrong times. If you’re an individual investor, you will face outside financial stresses, personal issues, health issues, etc. All of these things will have an effect on your trading that is hard to capture in the numbers, but prudent planning will allow you to navigate these challenges.

Trading Plan :10 Points

  
  Education
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The Trading Plan comes first and should account for the following parameters:

1.  Entering a trade. Quantified approved entries.

2.  Exiting a trade. Predetermined Exit point BEFORE you enter a trade.

3.  Stop Placement. How will you know you were wrong about a trade? A stop loss, trailing stop, chart signal, volatility stop, time stop, or target price.

4.  Money Management. How much capital will you risk on any one trade? This is the key to position sizing.

5. Position Sizing. How much capital will you put on any one trade? Do you have rules that tell you to trade bigger or smaller based on the odds?

6.  What to Trade. What qualifies stocks to be on your watch list?

7.  Trading Time Frames. Are you going to day trade or position trade and hold for a week or more? or will you be a short term or long term trend follower?

8.  Back Testing. You need back testing either with a computer, by reviewing charts, or others research to show that your system is a winner.

9.  Performance Review. You must keep a detailed log of your trades and watch your performance to understand the wins and losses and their causes.

10.  Risk vs. Reward. Each trade must begin with the potential of winning more money than you are risking.

This is a very basic outline, I suggest expanding this to include 30 rules minimum; 10 each covering the areas of risk management, psychology, and method. If you can write this, believe it, and follow it, you will win in trading the only question that remains is when?

6 Universal principles of successful traders

  
  Education
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1). Preparation

Author Brent Penfold is in the minority believing risk management is the #1 priority in trading. Brent believes that once you get your trading system and position size in place you must use the amount you will risk on each trade to determine your risk of ruin. The book shows exactly how to figure this out using Excel. His point is that if your risk of ruin is not zero then you will eventually blow out your account. Risking 1% to 2% of your capital in any one trade usually gives you a zero percent risk of ruin but it also depends on your systems win/loss ratio. But the point is to test any system with 30 trades first then determine your risk of ruin.

2). Enlightenment

Your most important goal is to lower your risk ruin to zero. In trading, the trader with the best ability to cut losses short wins. Simple trading strategies work the best based on traditional support and resistance while trading with the trend on either retracements of break outs. The 10% of winners in the market win by treading where others fear, buying on break outs when they first occur and going short when a new low is made, or buying into the abyss when a security finds support or resistance and reverses at the end of a monster trend.

3). Developing a trading style (more…)

5 Obstacles For Traders ,Just Cross Them & See Great Results

  
  Education
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  1. YOUR EGO: It wants you to PROVE you are right, it wants you to trade big, the ego wants you to be confident in your ability to trade before you are competent in your trading through the right education and experience.
  2. YOUR FEARS: Fear makes you afraid to take your entry when it is triggered and afraid to let a winner run thinking it will turn into a loser. Fear comes from a lack of faith and lack of faith arises from lack of the proper study before you start trading.
  3. YOUR GREED: It makes you trade too big and too much. Greed makes you want to risk too it all to get rich quick. Greed usually leads to get broke quick trades. Greed wants to take a short cut to success and you have to travel the full road to get to where you really want to go. You have to go through the work and experiences to get to success.
  4. NO TRADING PLAN: If you do not have a map it does not matter where you want to go you will end up somewhere else. Every trade should be planned when the market is closed and then executed reacting to prices when the market is open. With no plan long term results are virtually impossible.
  5. YOU: The weakest part of any trading system is the trader that is suppose to follow it. If you do not put in the work to develop a trading plan that fits you, develop and keep discipline, manage your risk, and stick to the plan regardless of how you feel then no trading system will work for you.

3 Reasons Traders Don’t Make More Money

  
  Education
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1) Position Sizing – They don’t take their largest risk when they have their greatest feel for the market and conviction about direction. Very high confidence trades may be sized relatively small; lower confidence trades are sized too large (often to make money back from earlier losses). They are taking their biggest cuts at the plate when the ball is out of their strike zones;
 
2) Execution – They wait for markets to go up before they buy and to go down before they sell. As a result, they get in at prices that leave them unusually subject to pullbacks. Many times, particularly if the trades are sized large (see above), the heat will take them out of good trades. In short, they’re not patient about getting into positions; they chase moves, fearful that they’ll miss a profit opportunity;
 
3) Rigidity – They don’t adapt to changing markets. They look for big moves in markets with declining volatility; they trade breakouts when signs point to range conditions. They set stops and profit targets in ways that don’t adapt to shifting volatility. They expect the market to accommodate what they’re doing rather than vice versa.
 
How much money you make is a function of what you trade and how you trade it. Many traders will switch what they trade (markets, stocks, time frames), only to continue making the same mistakes outlined above. Getting into good risk/reward trades and then maximizing the risk/reward while the positions are on is a major driver of long-term trading success.

Winning Traders Must Have These Three Elements

  
  Education
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Trading System

  • They trade a robust system or method that wins more money over time than it loses.
  • Their system gives them a reward to risk ratio that is in their favor.
  • Their system or method is proven to work with a live trading record over many markets and trades or has  historical back testing.

Trading with Managed Risk

  • They manage the risk of ruin to avoid blowing up their account.
  • They risk no more than 1%-2% of total account equity on any one trade.
  • They manage risk through proper position size so they do not risk their account and ability to trade int eh future on any one trade.
  • They do not risk more than 6%-12% of their capital at one time across multiple trades.

The Mind of the Trader

  • They have faith in their system or method and continue to trade it even when they are losing so they capture the wins when they start again.
  • Almost all winning traders have come back from blowing up their accounts or losing a lot of money, they persevered while many others quit before they won. You will have to do the same if you do not understand the risk of ruin .
  • Most winning traders have learned to separate their trading from their self worth and ego. They treat it like a business not an ego trip.

Your focus in your trading career should be like a laser on finding the right system & method, learning why it is so important to manage risk then doing it, and having the right mind set to stay disciplined, passionate, and focused to get into the winning circle. With these three elements incorporated into a trading plan you will eventually win big. If you are missing any one of these three elements in your trading the odds are that you will be out of the game quicklyeither after a string of losses, loss of faith in yourself or system, or loss of belief that winning at trading is even possible for you.

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