- Its psychologically comforting to construct a system that looks good in the past
- Learn from your losses
- Emotions do nothing for your trading
- It’s just another trade out of the next 1000
- System->Risk Management/Volatility Control->Trading Psychology
- “You have to enjoy trading, because if trading is a source of negative emotions, you have probably already lost the game, even if you make money.”
Archives of “mathematical finance” tag
rssWho we are as individuals is how we trade in the markets – Weaknesses and Strengths of Traders
Ambitious
Makes and follows long term business plan
•Unambitious
Will ignore long term business plan
•Calm
Will handle times of market volatility and make smart decisions
•Worrying
Will panic when markets are volatile and make stupid decisions
•Cautious
Strictly follows Stop-Loss rules and Protects Trading Capital
•Rash
Will not be diligent with Stop losses and will risk trading capital
•Cheerful
Handles losses and down times in markets (more…)
A Few Things About Risk
People have an amazing ability to discount risks that threaten their livelihood. That’s dangerous because people who should be the most experienced experts in a field may be the least able to objectively assess their industry.
Risk has a lot to do with culture. Europeans and Canadians are generally wary of the stock market. For Americans, it’s a pastime. The French prefer raw milk. Americans are warned against it. Canadians are banned from it. Europeans are terrified of nuclear exposure. Americans couldn’t care less. Walk through an international airport and you’ll see one person wearing a face mask to prevent the spread of illness and another letting their kid crawl on the floor. Everyone wants to believe they’re thinking objectively, but most of the time you’re just reflecting the cultural norms of where you were born.
Success is an underrated risk. Jason Zweig once wrote: “Being right is the enemy of staying right — partly because it makes you overconfident, even more importantly because it leads you to forget the way the world works.”
Risk’s greatest fuels are debt, overconfidence, impatience, a lack of options, and government subsidies.
Its greatest enemies are humility, room for error, and government subsidies.
Nothing in the world can give a damn less than risk. Risk doesn’t care about your political views or your morals. It doesn’t care what your view of the market is, or what you were taught in school. It’s an indiscriminate assassin and a master at humbling ideologies.
A Trader’s Real Opponent
The day the trader stops blaming the markets, politicians, or ‘They’ and ‘Them’ for losses and starts taking responsibility for their own trading could be the day that they begin to change from losing money to making money. In the end the market is like the ocean and we are the surfer, we choose the surfboard and the waves and the ocean really doesn’t care what we do it’s just there. The quality of our ability to ride a wave is based on our skills, technique, and experience our emotions contain no edge. In the end we win or lose based on our ability to overcome our own weaknesses.
Market price action is neutral to our existence, it is our method that determines our profitability and we choose how we will trade.
Profitability comes from our total trading profits being bigger than our total trading losses, we control our entries and exits.
The size of our draw down in capital is determined by the quality of our risk management and we manage our own risk.
Trading too big for a trading account size almost guarantees failure, we control our own position sizing.
Profitability only comes from trading with an edge, we are responsible for finding and trading with our own edge.
10 One Liners For Traders
• Technical analysis is a windsock, not a crystal ball. It is a skill that improves with experience and study. Always be a student, there is always someone smarter than you!
• “Thou Shall Not Trade Against the Trend.”
• Let volatility work in your favor, not against you.
• Watch what our “Politicos” do, not say.
• Markets tend to regress to the mean over time.
• Emotions can be the enemy of the trader and investor, as fear and greed play an important part of one’s decision making process.
• Portfolios heavy with underperforming stocks rarely outperform the stock market!
• Even the best looking chart can fall apart for no apparent reason. Thus, never fall in love with a position but instead remain vigilant in managing risk and expectations. Use volume as a confirming guidepost.
• When trading, if a stock doesn’t perform as expected within a short time period, either close it out or tighten your stop-loss point.
• As long as a stock is acting right and the market is “in-gear,” don’t be in a hurry to take a profit on the whole position, scale out instead.
Overconfidence & Greed
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:
4 Points to Deal With Trading Losses
- Consider yourself a manager of bad trades. The profitable trades will look after themselves – sit back and let the profits run. However when a trade turns against you, cut your losses quickly and move onto the next trade.
- Find a trading strategy that works and validate it. You may design your own trading system, you may purchase a strategy or follow someone else’s advice but the key is to find a strategy that suits your personality. If you are comfortable and confident that your strategy works then you are more likely to stick with it when the losses come (and they will come!)
- Never second-guess your strategy. If your trading rules are telling you to exit a position…then get the hell out! Don’t presume you know more than the market. Don’t wait to see if a bad trade will turn around in your favor. It may, but it may continue to go against you and therefore create larger losses.
- Reality check: you WILL have losing trades. The goal is to make the losses insignificant so you are not taken out of the game and unable to keep trading. Large trading losses cause damage to your investment capital AND to you psychologically. It is very hard to step back up to the plate and take the next trade if you have a huge trading loss. Therefore, have a very clear risk management strategy and stick to it.
4 Type of Market Cycles
1) Bottoming process – At market lows, we tend to see an elevation of volume and volatility and a high level of market correlation, as stocks are dumped across the board. Selling pressure far exceeds buying pressure and sentiment becomes quite bearish. At important market bottoms, we see price lows that are not confirmed by market breadth, as strong stocks begin to diverge from the pack and attract buying interest. At those bottoms, we also find a rise in buying pressure and a reduction of selling pressure, as fresh market lows fail to attract new selling interest.
2) Market rise – With the drying up of selling, low prices attract buying from longer timeframe participants as well as shorter-term opportunistic ones. The market rises on strong buying pressure and low selling pressure, and the rise generates sufficient thrust to generate a good degree of upside momentum. Volatility and correlation remain relatively high during the initial lift off from the lows and breadth is strong. Dips are bought and the rise is sustained.
3) Topping process – The market hits a momentum peak, often identifiable by a peak in the number of shares registering fresh highs. Selling from this peak generally exceeds the level of selling seen during the market rise, but ultimately attracts buyers. Weak stocks begin to diverge from the pack and fresh price highs typically occur with breadth divergences and lower levels of correlation. New buying lacks the thrust of the earlier move from the lows and volatility wanes. By the time we hit a price peak for the cycle, divergences are clear, volatility is low, both buying pressure and selling pressure are low, and sentiment remains bullish.
4) Market decline – Fresh selling creates a pickup in correlation and volatility, as short-term support levels are violated and selling pressure exceeds buying pressure. Breadth turns negative and the bulk of stocks now move lower.
Weaknesses and Strengths of Traders
Ambitious
Makes and follows long term business plan
•Unambitious
Will ignore long term business plan
•Calm
Will handle times of market volatility and make smart decisions
•Worrying
Will panic when markets are volatile and make stupid decisions (more…)
Why Is Trading So Hard?
At one point or another, everyone who has interactions with the market asks oneself, “Why is trading so hard?” There are legitimate reasons why trading should be difficult: markets are highly random; whatever edge we can find is eroded by competition from smart, well-capitalized traders; some traders work within various constraints; and markets are subject to very large shocks that can have devastating effects on unprepared traders. Even so, it seems like something else is going on, almost like we are our own worst enemies at times. What is it about markets that encourages people to do exactly the wrong thing at the wrong time, and why do many of the behaviors that serve us so well in other situations actually work against us in the market?
Part of the answer lies in the nature of the market itself. What we call “the market” is actually the end result of the interactions of thousands of traders across the gamut of size, holding period, and intent. Each trader is constantly trying to gain an advantage over the others; market behavior is the sum of all of this activity, reflecting both the rational analysis and the psychological reactions of all participants. This creates an environment that has basically evolved to encourage individual traders to make mistakes. That is an important point—the market is essentially designed to cause traders to do the wrong thing at the wrong time. The market turns our cognitive tools and psychological quirks against us, making us our own enemy in the marketplace. It is not so much that the market is against us; it is that the market sets us against ourselves.