Archives of “mathematical finance” tag

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THREE LEGS OF SUCCESSFUL TRADING

  
  Education
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If you ever read any book on trading you would notice that every author our there talking about three most important things of successful trading and investing are:

  1. Trading edge
  2. Money management
  3. Discipline or psychology

Depending on the book one is reading one of those three are emphasized more or less. If you read book on technical analysis author will say that having edge is most important, and even if you have PhD in psychology if you don’t have proper edge you will not be able to make money.

If you read book on psychology again author will tell you that you can have best trading system on the world if you are not able to take signals you will not be successful trader and that you must make system that will suit your personality.

Finally if you read book on money management, author will tell you that even if you have best system in the world and having best discipline in the world if you risk too much of your capital on each trade you will probably ruin your account and the game will be over.

That post made me think about is it really like that, can we represent those three characteristic as pyramid. Is one more important than the other?
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Why Traders Have Problems

  
  Education
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Today I read another article that went along these lines- here are some excerpts:

On why traders have problems:

No, it is not your fear of losing, it isn’t your inability to read the market correctly, nor is it your lack of charting knowledge that causes your trading difficulties.

In a nutshell: The number one reason for all your problems revolves around the fact that you have reality back to front.”

The author then goes on to explain what they mean – that our mind is focused on the wrong things- that we are weighed down by preconditioning.

 The presented solution:

“First of all you must let go of the idea that you need to fix your trading. No, you don’t need to fix your trading, in fact, you don’t really need to fix anything. How can you? You are looking at old stuff that was created yesterday. However, you do need to fix the way you look at your life in general. This requires that you learn a thing or two about how you generate reality, learn a few basic things about quantum physics and understand how this applies to your trading and indeed to your life.

Your refusal to do this and instead carry on with the same old tried and tested paradigms, expecting different results in your trading account, is akin to placing a plaster on a festering wound.”

(more…)

5 Ways -Traders are Right ,But …. Still Lose Money.

  
  Education
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  1. You enter your trade correctly and it goes in your favor, BUT… you do not have the right exit strategy to capture your profits and they evaporate due to not having a trailing stop or waiting to long to exit to bank those profits. Sometimes winners even turn into big losers win not managed correctly. You have to have a plan to take profits while they are there.
  2. You enter the right trade BUT… at the wrong time, you either exit not allowing your trade enough time to work or you are stopped out but do not have a plan to get yourself back in the trade with the right set up. The right trade with the wrong timing pays nothing.
  3. You have the right entry and it goes in your favor BUT.. you pick the wrong stock option to express your trade. If you pick an option with a high implied volatility your trade has to overcome that vega priced into the option, after an expected earnings event that vega value will be priced out and you need the move in intrinsic value to make up that difference. With a far out in time stock option you need the price to move enough in the underlying in the time period of the option to make up the theta cost of time embedded in the option. It is crucial to understand the option pricing model to make the right option trades to express your time period and expected move. Sometimes options also do not have the liquidity in some stocks,or far out time frames, or far out of the money strikes. Getting in and out of an illiquid  option trade can be very expensive.
  4. You enter correctly BUT… get stopped out too soon because your position size is just too big and either you stop out from a monetary loss above your risk threshold or your fear of big losses stops you out. Trade the right size for your risk tolerance and give yourself some wiggle room.
  5. Your trade can be perfectly timed and executed and it can immediately go in your favor BUT… an unexpected news headline about your company, interest rates, commodity, or macro can still cause you to lose. Nothing you can do about this one but move on the next trade. The other four can be great lessons in how to be a winner the next time around.

10 Tips For Managing Trader Stress

  
  Education
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Traders should never underestimate the role that stress plays in their trading. Many more will succeed or fail based on their ability to handle stress than will have their winning and losing determined by a robust method, mentor, or risk management. It is even possible for a trader to win consistently and still not be able to win in the long term due to the fact that they can not get comfortable being uncomfortable with capital on the line with an unknown outcome. Others will simply burn themselves out stressing excessively while losing and also stressing when they win scared they will give back their profits. If you are  going to be a successful trader you will need to manage the weakest link in any trading system: the trader. Stress management is the traders weakest spot. You have to be able to handle the heat of trading so you don’t melt.

 Here are the ten ways to manage your stress in trading:

1). When you get over excited calm down by concentrating on your breath.
2). Never trade so big that one trade will make or break your account, trading career, or lifestyle. 
3). Only trade systems and methods that you fully understand and have faith in for profitable in the long term.
4). Visualize yourself being a success as a trader.
5). Slow down your trading to a pace that does not rattle your nerves. 
6). Connect with like minded traders that understand your battles and goals.
7). Study and do so much homework about trading that you begin to have unshakable confidence in yourself. 
8). Stop doing what does not work in your trading and start doing more of what does work for you and makes you money.
9). Do not let others shake your confidence, do not accept any unsolicited advice from anyone, stick to your game plan. 
10). Accept your losses quickly when stops are hit to avoid emotional damage and stress from big losses.

Do everything you can to prevent the damaging effects of stress on your trading and life. (more…)

Overconfidence & Greed

  
  Education
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What most traders often don’t realize until it is too late is how quickly one can lose a lot of money in a single trade often with disastrous consequences.  More often than not this painful experience comes from poor risk management following a period of successful trading. It is natural of course. We are pattern seeking mammals and when something starts working for us we get confident in our abilities and quickly forget we know very little what the market or a given stock may do at any given moment. In short: We easily become overconfident.

It is after a period of successful trading that traders tend to loosen up on good intentioned rules of discipline. They start thinking in term of dollar signs as opposed to the trade discipline. In short they think they can fly. “Look how much money I would have made if I had traded x % of my portfolio”. Stop yourself right there. While it is tempting to play mind games like this no good will come of it. Why? Because you just stepped overtly into the realm of one of the greatest sins of trading:

Once you get greedy you will start abandoning necessary discipline. Nobody, I repeat nobody, no matter how smart they think they are has a fail proof system or process or secret trading technique that guarantees 100% success. I surely don’t. Neither does Goldman Sachs or anybody else. While there may be some HFT firms out there that are trying to algo their way to a perfect system I have news for you: You are not an HFT or an algo. You are an individual trader and as good as you may be: You will have losing trades, things will go against you and oddly enough this will happen when you are at your most vulnerable: When you are overconfident, greedy and overexposed. Something curious tends to happen though when the losing trade occurs:

‘The Psychology of Trading-Book Review

  
  Education
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Author Brett Steenbarger has done a great job with this book. He covers what I personally believe is the most important element in trading: psychology.

New traders will probably not last through their first year in the markets without blowing up their accounts by taking losses too personally. Many times draw downs cause traders to start gambling when they become desperate to recover their losses. Many times increasing position size when they should be decreasing it is an ego-driven desperation to get back their losses. Other similar bad mental behaviors creep into our trading careers as dysfunctions in our personal lives cloud our minds from being able to make the right decisions in following our systems and established trading principles.

What this book shows is how to take the proper perspective and observe our greed and fear, enabling us to see them for what they are instead of getting caught up in these powerful emotions that lead to terrible consequences in our accounts and lives.

This book is a very good book on both psychology and trading. It is packed with lessons from the authors patients and his own experiences. What the book shows is that we are the most important element in our trading. We must have the right mind set in trading, and while developing as a trader we need to keep a log of the emotions we feel on our losses and wins to better understand ourselves and why we make emotional charged decisions that we shouldn’t while trading. (more…)

Market-Neutral Trading-Thomas Carr (Book Review )

  
  Education
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Thomas Carr is the CEO of an advisory and trader training service, designer of a MetaStock add-on toolkit, and partner in an investment firm. Known online as Dr. Stoxx, he is the author of Trend Trading for a Living and Micro-Trend Trading for Daily Income. His latest work is Market-Neutral Trading: Combining Technical and Fundamental Analysis into 7 Long-Short Trading Systems (McGraw-Hill, 2014).
Carr is an excellent marketer which, as might be expected, is the downside of this book. Without the tools that he sells, the reader cannot implement all of the book’s strategies. He may not even gain the confidence to trade any of them since Carr admits that “blindly following a set of systems” doesn’t work. When real money was on the line, he traded “in a very detached, mechanical fashion” and lost a lot of money—both in his own account and in a small fund for clients. By contrast, he made a lot of virtual money for the subscribers of his newsletters. The difference (aside from the obvious real vs. paper money distinction) was that he added discretion when making calls for his newsletters. He applied “God-given skills of discretionary analysis, skills that [had] been honed by years of apprenticeship under some of the great masters of the game, in addition to a long slog of real-time, real-money trading experience.” (p. 131) How does a trader learn the discretion that is necessary to make trading systems profitable? “You need to find a mentor who already has it and sit by their side for a while.” (p. 134) Yes, Carr is also a mentor.
Now that you know that, without a further outlay of funds to Carr, you won’t be able to trade all of the systems described in this book and that, even if you can trade them all, you will still lose money if you don’t overlay them with a large dose of discretion (gained only by spending still more money), what does this book have to offer?  (more…)

Universal Lessons

  
  Education
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What follows are some of the most well-known investment disciplines along with a lesson or two from each that every investor should be able to use in their own strategy.

Focused Value Investing: Buying stocks that are underpriced in relation to their intrinsic value.
Lesson(s): It’s important to invest from the perspective that stocks represent an ownership interest in a business. You get your share of corporate profits from the stocks you own and over the long-term the value of the business should be reflected in the stock price.

Quantitative Investing: Using a systematic, mathematical approach to make buy and sell decisions within a portfolio.
Lesson(s): A rules-based, objective approach to investing is a great way to take out the emotions which can trip up so many investors and introduce biases into the investment process. Automating good decisions can reduce costly mistakes.

Technical Analysis: Studying charts, past prices and volume for security and market analysis by using patterns.
Lesson(s): An understanding of the history of the financial markets is extremely important to be able to define your tolerance for risk and gain the correct perspective on what couldhappen in terms of gains and losses. And at the end of the day markets rise and fall because of supply and demand.

Index Investing: Owning the entire market/index at a low cost.
Lesson(s): Beating the market is hard. Keeping your expenses, activity and turnover to a minimum is a prudent way to earn your fair share of the market’s return over time. (more…)

Psychology & Risk Management For Traders

  
  Education
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PSYCHOLOGY

  1. I keep Blue Channels turned off while trading.
  2. I do not care about others opinions I care only about price and chart action.
  3. I do not try to predict, instead I trade in accordance with the chart.
  4. I am not trying to prove I am right I am trying to make money.
  5. I am not trading for ego gratification I am trading for money.
  6. I am not trying to be the genius who calls a top I am the trend follower who follows a trend all the way up until it ends.
  7. I admit freely to my losing trades along with my winning trades.
  8. I do not get emotionally attached to each price movement through out the day.
  9. I have faith in my rules, methodology and system.
  10. I understand it that it is the market conditions and not me that creates profits.

RISK MANAGEMENT

  1. I never add to a losing positions.
  2. I carefully control position sizing to limit risk based on volatility.
  3. I attempt to never lose  more than 1% of my capital on any one trade.
  4. I trade smaller when volatility is high.
  5. I sell positions with volatility stops when daily ranges double in the wrong direction.
  6. I have stale stops and sale positions that do not trend in four days after entry.
  7. I quickly sell losing trades when my stop is hit.
  8. I sell stocks when they close in the bottom of the days range.
  9. I never expose more than 6% of my capital to possible loss at any one time.
  10. Risk is priority #1, profits are #2.

Ed Seykota-Quotes Collection

  
  Education
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RELAX-READEd Seykota’s Trading Style

  • My style is basically trend following, with some special pattern recognition and money management
    algorithms.
  • In order of importance to me are: (1) the long-term trend, (2) the current chart pattern, and (3) picking a good spot to buy or sell. Those are the three primary components of my trading. Way down in very distant fourth place are my fundamental ideas and, quite likely, on balance, they have cost me money.
  • I consider trend following to be a subset of charting. Charting is a little like surfing. You don’t have to know a
    lot about the physics of tides, resonance, and fluid dynamics in order to catch a good wave. You just have to be able to sense when it’s happening and then have the drive to act at the right time.
  • Common patterns transcend individual market behavior (my note: i.e. price patterns are similar across different markets).

Overall Rules

  • Trade with the long-term trend.
  • Cut your losses.
  • Let your profits ride.
  • Bet as much as you can handle and no more.

Buying on Breakouts

  • If I were buying, my point would be above the market. I try to identify a point at which I expect the market momentum to be strong in the direction of the trade, so as to reduce my probable risk.
  • I don’t try to pick a bottom or top.
  • If I am bullish, I neither buy on a reaction, nor wait for strength; I am already in. I turn bullish at the instant
    my buy stop is hit, and stay bullish until my sell stop is hit. Being bullish and not being long is illogical. (more…)
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