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?
Regardless of how you trade or invest … you better have those answers in advance of betting real money.
Archives of “mathematical finance” tag
rss5 Trading Lessons-Must Read
- Most of the time, markets are very close to efficient (in the academic sense of the word.) This means that most of the time, price movement is random and we have no reason, from a technical perspective, to be involved in those markets.
- There are, however, repeatable patterns in prices. This is the good news; it means we can make money using technical tools to trade.
- The biases and statistical edges provided by these patterns are very, very small. This is the bad news; it means that it is exceedingly difficult to make money trading. We must be able to identify those points where markets are something a little “less than random” and where there might be a statistical edge present, and then put on trades in very competitive markets.
- Technical trading is nothing more than a statistical game. The parallels to gambling and other games of chance are very, very close. A technical trader simply identifies the patterns where an edge might be present, takes the correct position at the correct time, and manages the risk in the trade. This is, of course, a very simplified summary of the trading process, but it is useful to see things from this perspective. This is the essence of trading: find the pattern, put on the trade, manage the risk, and take profits.
- Because all we are doing is playing the small edges as they occur in the markets, it is important to be utterly consistent in every aspect of our trading. Many markets have gotten harder (i.e. more efficient, more of the time) over the past decade and things that once worked no longer work. Iron discipline is a key component of successful trading. If you are not disciplined every time, every moment of your interaction with the market, do not say you are disciplined.
5 Characteristics of less Successful Traders
1) The less successful traders are anticipating market movement and trading accordingly. The highly successful traders are identifying asset class mispricings and trading off those.
2) The less successful traders are trading particular instruments and pretty much stick to those. The highly successful traders recognize that any combination of trading instruments can be considered an asset class and appropriately priced (and gauged for mispricing).
3) The less successful traders think of their market as *the* market. The highly successful traders focus on interrelationships among markets that cut across nationalities and asset classes.
4) The highly successful traders place just as much emphasis on understanding markets as predicting them. The less successful traders don’t ask “why” questions.
5) The less successful traders are convinced they have proprietary information of value that they must not disclose to anyone. The highly successful traders use their proprietary information to selectively share with other highly successful participants, thereby gaining a large informational edge.
If I had to use one phrase to capture the essence of the highly successful traders, it would be analytical creativity. These traders are creative in their thinking about markets and rigorous in their pursuit of this creativity.
Physics To Help Deal With Market Risks
Misako Takayasu, a Tokyo Institute of Technology associate professor, spoke with The Nikkei about how “big data” will be used in the future to help market players manage risks based on principles of physics.
Excerpts from the interview follow.
Q: How do you use big data in your research?
A: Big data has allowed us to record human behavior and analyze it mathematically. Broader economic or social phenomena can be observed more clearly (in this way), like particles in physics.
As more and more trading data is accumulated, it is becoming increasingly possible to analyze and predict fluctuations using methods common in physics. The exponential growth of computer calculation speeds has also helped the process.
Q: What can you deduct from market data using these tools?
A: Data on ticks — the smallest increment of movement in the price of a security — can be used to gauge investor sentiment and how volatility is triggered. Market swings cannot be explained by a simple random-walk theory.
Markets become more stable when the number of contrarian investors increases. Conversely, they become unstable when more and more investors follow a market trend.
If market-followers dominate a market as it continues to climb, it will crash in the end. We may be able to explain the dynamics of a bubble with big data.
Q: What are the possible applications of big data in the market? (more…)
Trader Psychology
- Transcending Common Trading Pitfalls
- All market behavior is multifaceted, uncertain, and ever changing.
- “I am employing a robust, positive expectancy trading model and am appropriately managing risk on each and every trade. Losses are an inevitable and unavoidable aspect of executing all models. Consequently, I will confidently continue trading.”
- Denial of loss and uncertainty is extremely destructive because it prevents us from thinking in terms of probabilities, planning for the possibility of loss, and consequently from the necessity of consistently managing risk.
- If we view markets as adversarial we cut ourselves off from emotionally tempered, objective solutions to speculation (opportunities to profit)
- Blind faith is no substitute for research, methodical planning, stringent risk management, playing the probabilities, and unwavering discipline
- Depression is a suboptimal emotional state because it allows past losses or missed opportunities to limit our ability to perceive information about the markets in the present
- We are not our trades; they are merely an activity in which we are engaged
- Greed is linked to fear of regret, which is the greatest force impeding a trader’s performance outside of fear of loss
- Market offers limitless opportunities for abundance
- Trading biases prevent us from objectively perceiving reality, thereby limiting our ability to capitalize on various opportunities in the markets.
10 Unsuccessful Trading Behaviors
- Refusing to define a loss.
- Not liquidating a losing trade, even after you have acknowledged the trade’s potential is greatly diminished.
- Getting locked into a specific opinion or belief about market direction. I.E. “I’m right, the market is wrong.”
- Focusing on price and the money
- Revenge-trading to get back at the market from what it took from you.
- Not reversing your position even when you clearly sense a change in market direction
- Not following the rules of the trading system.
- Planning for a move or feeling one building, then not trading it.
- Not acting on your instincts or intuition
- Establishing a consistent patter of trading success over a period of time, and then giving your winning back to the market in one or two trades.
3 Trading Mistakes
1) Trading Without Context – Many traders will enter positions with little more than a chart-based “setup” or a hunch that the market is heading lower. They don’t locate where the market is trading with respect to its daily range and often can’t identify where the relevant ranges are located. Is the most recent market move gaining or losing volume/participation? Are most sectors participating in the move? Without context, traders trade reflexively, not proactively.
2) Trading Without Targets – Focused on entries, traders often don’t explicitly identify where they would harvest profits. They hold trades too long, exiting in a panic after reversals, or they take profits quickly, missing opportunity. They don’t factor current volatility into estimates of how far the market could move on their time frame, and they often don’t explicitly look for targets based upon prior moves and ranges.
3) Trading Without Reflecting – The slow times of day are excellent opportunities to review trading for the day, reformulate market views, correct mistakes, and set goals going forward. Many traders, however, never stop looking for the next trade, lured by the siren’s promise of breakout. Without the benefit of reflection, they compound errors, turning mistakes into blowups and blowups into slumps.
The Disciplined Trader: Developing Winning Attitudes by Mark Douglas
Intro
- Reaching the level of success they desire as traders will require them to make at least some, if not many, changes in the way they perceive market action.
- The markets have absolutely no power or control over you, no expectation of your behavior, and no regard for your welfare.
- There are only a few traders who have come to the realization that they alone are completely responsible for the outcome of their actions. Even fewer are those who have accept the psychological implications of that realization and know what to do about it.
- The nature of the markets made it easy no to have to confront anything that otherwise might be perceived as a problem because the next trade always had the possibility of making everything else in one’s life seem irrelevant.
- I CREATED MY LOSSES INSTEAD OF AVOIDING THEM SIMPLY BECAUSE I WAS TRYING TO AVOID THEM.
- Unsuccessful Trading Behaviors
- Refusing to define a loss.
- Not liquidating a losing trade, even after you have acknowledged the trade’s potential is greatly diminished.
- Getting locked into a specific opinion or belief about market direction. I.E. “I’m right, the market is wrong.”
- Focusing on price and the money
- Revenge-trading to get back at the market from what it took from you.
- Not reversing your position even when you clearly sense a change in market direction
- Not following the rules of the trading system.
- Planning for a move or feeling one building, then not trading it.
- Not acting on your instincts or intuition
- Establishing a consistent patter of trading success over a period of time, and then giving your winning back to the market in one or two trades.
Your Trading Method-10 Points
1.“Trade What’s Happening…Not What You Think Is Gonna Happen.” – Doug Gregory
2. Go long strength; sell weakness short in your time frame.
3. Find your edge over other traders.
4. Your trading system must be built on quantifiable facts not opinions.
5. Trade the chart not the news.
6. A robust trading system must either be designed to have a large winning percentage of trades or big wins and small losses.
7. Only take trades that have a skewed risk reward in your favor.
8. The answer to the question, “What’s the trend?” is the question, “What’s your timeframe?” – Richard Weissman. Trade primarily in the direction that a market is trending in on your time frame until the end when it bends.
9. Only take real entries that have an edge, avoid being caught up in the meaningless noise.
10. Place your stop losses outside the range of noise so you are only stopped out when you are likely wrong.
The Universal Principles of Successful Trading – 5 Points
A book review for Brent Penfold’s book “The Universal Principles of Successful Trading: Essential Knowledge for All Traders in All Markets”
This book is excellent for traders that are ready to accept its lessons. You need a foundation in trading to understand the importance of what the book is advising, and take the principles seriously with an open mind. Once you are through the rainbow and butterfly phase of trading, and realize that you will not be a millionaire in a year, this book will help you get focused and become serious about trading.
Here are the six universal principles of successful traders:
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. He believes 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. Make sure to test any system with a minimum of 30 trades and then determine your risk of ruin. I would advise a larger sample size in multiple market environments. A trend following system that looks brilliant in a trending market may result in a 50% draw down in a choppy or range bound market.
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 levels, while trading with the trend on either reversals or break outs. The 10% of winning traders 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. Buying into key reversals when a security finds support or resistance, and reverses at the end of a monster trend, is also a tactic of winning traders.
3). Developing a trading style
You must choose your own personal style of trading: swing trading, trend trading, etc. You must also trade based on your chosen time frame: intraday, short term, medium term, or long term. (more…)