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Chess Lesson That Can Really Help Profits

There are useful parallels between chess and trading.  In the below quotation there is actually more than one lesson for those willing to consider it.   

Pal Benko, a chess grandmaster said: 

“Patience is the most valuable trait of the endgame player. In the endgame, the most common errors, besides those resulting from ignorance of theory, are caused by either impatience, complacency, exhaustion, or all of the above.” 

1) Ignorance of theory

2) Impatience / Patience

3) Complacency

4) Exhaustion

See this 1 chess lesson morphed into 4 lessons:

Let me have a little go at highlighting some things that we can perhaps learn from this chess quote that apply to trading.  (I’d love it if you told me yours in the comment section below. Go on, be brave and join in – dialogue is good :-))

1) Ignorance of Theory 

Ed Seykota has been recorded as saying something like: until you master the basic literature and spend some time with successful traders, you might consider confining your trading to the supermarket.  

Naturally with trading, getting comfortable with the basics is an important step.  Make sure, however, not to end up one of those paralysed and stuck in student mode.  At some point you have to be willing to move from student to trader. One of the useful ways of ‘spending time with traders’ if you are not employed in a trading firm is to utilise things like Stocktwits, trading groups, forums etc. (more…)

Gambling vs. Trading

“Gambling is taking a risk when the odds are against you.  Speculating is taking a risk when the odds are in your favor.”  Victor Sperandeo

“the only difference between gambling and trading is that your amount at risk and amount of potential reward varies with trading.”  I agree, but there’s more to it.  The parallels are obvious, from the lack of control over outcome to the illusion of knowledge to the physiological effects of having a stake in the outcome.  However, the differences are substantial…and mostly mathematical.

The expectancy in gambling is ALWAYS terrible, while market speculation at times offers outstanding opportunities.  To get a 2:1 or 3:1 opportunity in gambling, one needs to accept incredibly low odds of victory.  In financial markets, those 2:1 or above opportunities come around like clockwork and offer high enough probability that long-term positive expectancy is possible.  Not only that, but the market speculator has the opportunity to adjust his or her position after the game begins…when was the last horse race where you could take a little off the table after the first turn?  Or reclaim most of your bet when your horse stumbles out of the gate?

I’ll leave the neuroscience to the experts, but it seems to me that we need to coordinate our left brain(rational) and right brain(experiential) in laying out the role of each.  We want to allow our intuition to shine through, but within the overall structure of positive expectancy.  No matter how hard one tries, the math of gambling can’t come close to touching the opportunities for building a business out of the markets.

Ernest Hemingway-The Old Man and the Sea

‘The Old Man and the Sea’ is my favourite work by Hemingway. Here are two quotes that have direct parallels with trading:  

He looked down into the water and watched the lines that went straight down into the dark of the water. He kept them straighter than anyone did, so that each level in the darkness of the stream there would be a bait waiting exactly where he wished it to be for any fish that swam there. Others let them drift with the current and sometimes they were at sixty fathoms when the fishermen thought they were at a hundred. But, he thought, I keep them with precision. Only I have no luck any more. But who knows? Maybe today. Every day is a new day. It is better to be lucky. But I would rather be exact. Then when luck comes you are ready.’ 

And the great sea with its friends and its enemies. And bed, he thought. Bed is my friend. Just bed, he thought. Bed will be a great thing. It is easy when you are beaten, he thought. I never knew how easy it was. And what beat you, he thought. ‘Nothing’, he said aloud. ‘I went out too

Trading Lessons

  • 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.
  • It is possible to trade effectively as a purely systematic trader or as a discretionary trader, but the more discretion is involved the more the trader himself is a key part of the trading process. It can be very difficult to sort out performance issues that are caused by markets, by natural statistical fluctuations, by the trading system not working, or by the trader himself. (more…)

Surfing and Trading

– After a lull (chop, quiet market) a new set of waves (setups, breakouts) will appear. Often, the first wave is not the best wave. Don’t get too excited because you see an OK wave (false breakout) after you haven’t seen any good ones at all. Often there is a better one behind it (look for confirmation).

– If you catch a wave ride it as long as you can, until you see yourself heading into shore, rocks, or other people (end of trend).

– Get into position and be ready to go for a wave so you’re ready to take a good setup once it appears. (focus, attention)

– Once you see a wave you want, commit to it to getting on it. Paddle as fast as you can to get enough speed to go with the wave. (have a plan, preparation, confidence with entry, execute with precision)

– Don’t try to catch the wave too early, make sure it has built up enough energy to carry you along (overly eager entries, wait for confirmation)

– Don’t catch the wave too late or else you’ll catch it on the top of the wave and it will throw you down into the seabed (buying tops or selling bottoms)

– Don’t try to surf every wave (over trading), just the ones that look easy to catch and worth the energy required to catch and ride it (capital preservation, high probability trades)

Any other surfers out there have some surfing/trading parallels? – If there’s no waves (setups) be patient and enjoy the water and sun. A setup will come. If not, then it wasn’t meant to be (sit on hands day) or not a good spot (market). Come back tomorrow or find another spot. Don’t try to make something of nothing.

Important Trading Lessons

These are some of those fundamental and undeniable truths, as I have come to understand them over the course of my trading career:

  • 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. (more…)

Ernest Hemingway

‘The Old Man and the Sea’ is my favourite work by Hemingway. Here are two quotes that have direct parallels with trading:  

He looked down into the water and watched the lines that went straight down into the dark of the water. He kept them straighter than anyone did, so that each level in the darkness of the stream there would be a bait waiting exactly where he wished it to be for any fish that swam there. Others let them drift with the current and sometimes they were at sixty fathoms when the fishermen thought they were at a hundred. But, he thought, I keep them with precision. Only I have no luck any more. But who knows? Maybe today. Every day is a new day. It is better to be lucky. But I would rather be exact. Then when luck comes you are ready.’ 

And the great sea with its friends and its enemies. And bed, he thought. Bed is my friend. Just bed, he thought. Bed will be a great thing. It is easy when you are beaten, he thought. I never knew how easy it was. And what beat you, he thought. ‘Nothing’, he said aloud. ‘I went out too far.’

Patience Is the Most Valuable Trait of the Endgame Player

John Hussman writes:

I’ve long been fascinated by the parallels between Chess and finance. Years ago, I asked Tsagaan Battsetseg, a highly ranked world chess champion, what runs through her mind most frequently during matches. She answered with two questions – “What is the opportunity?” and “What is threatened?”

He adds:

The final minutes of a Chess game often go something like this – each side has exhausted most of its pieces, and many pieces that have great latitude for movement have been captured, leaving grand moves off the table. At that point, the game is often decided as a result of some seemingly small threat that was overlooked. Maybe a pawn, incorrectly dismissed as insignificant, has passed to the other side of the board, where it stands to become a Queen. Maybe one player has brought the King forward a bit earlier than seemed necessary, chipping away at the opponent’s strength and quietly shifting the balance of power. Within a few moves, one of the players discovers that one of those overlooked, easily dismissed threats creates a situation from which it is impossible to escape or recover.

Hussman lays out a great case for trend following–even though that is not his intent.

Some behaviors that virtually guarantee losses in the markets

Lack of discipline: It takes an accumulation of knowledge and sharp focus to trade successfully. Many would rather listen to the advice of others. They just want to believe, like Fox Mulder.

Impatience: Some have an insatiable need for action. The day trading adrenaline rush and the gamblers’ high can have heroin-like addiction pull.

No objectivity: Some are unable to disengage emotionally from the market. They create a virtual “lifelong” marriage to their trades. Divorce is not an option.

Greed: A desire for quick profit blinds many from the diligent work needed to actually win in the long run.

Refusal to accept truth: Some do not want to believe that the only knowable truth is price action. They feel more secure following cult leaders serving Kool-Aid.

Impulsive behavior: Many jump into investments based on the morning paper or Good Morning America. Thinking that if you act quickly, somehow you will beat everybody else in the great race is a recipe for a messy failure.

Inability to stay in the moment of now: To be a successful trader, you cannot spend your time thinking about how you are going to spend your profits. Trading because you have to have money is not workable.

Stay open-minded: Come into the day knowing your future steps. Do not be stubborn when the market does not go your way. Cut your losses and follow your stinking trading plan.

Avoid false parallels: Just because the market behaved one way in 1995, 2000, or 2008 does not mean a similar pattern today will give you the same result. A great example of this: The Hindenburg Omen. It is a technical analysis pattern that is said to portend a stock market crash. The problem: Sometimes it is right, sometimes not. You don’t want to bet your life savings on a coin flip.

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