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Mike,
At Friday, November 09, 2001 1:39 PM you wrote:
"From: "Mike Brett" <mbrett@xxxxxxxxx>
To: <realtraders@xxxxxxxxxxxxxxx>
Subject: Re: [RT] Day Trade the emini?
Earl,
I agree with your statement below regarding trading and psychology. What
have you found helpful to guard against the psychological pitfalls that
seem
so prevalent for traders?"
There are of course many answers to your question.
Hope this story of two mythical, but oh so real traders, helps a
little.
Sometimes traders try to develop trading systems before they:
- have
an edge,
- know
they have an edge.
Since traders trade their confidence these are rather useful aspects to
have in place.
We will look at two types and levels of confidence - two stories of two
traders.
A Common Traders Story
Imagine I have read about a trading system based on the 80% cut-over
of the momentum curve with the 200 day exponential moving average when
simultaneous with an appearance of a doji on a full moon.
This catches my imagination, so I back-test this on my favourite
market(s).
Wow, what a trading system - a 3 to 1 win to loss ratio, wins 5.56 time
the value of losses.
Drawdowns - well trivial. Dealing expenses seem to make
little difference.
The Holy Grail, Eureka, Wow! Can't wait to get at those
markets!
Do I have an edge? Do I know if I have an
edge? Well, four or five or six losses in a row and
doubts begin to come between me and my Holy Grail.
A Rarer Traders Story
An investigation of past stock picking skills is
undertaken.
When index movements are stripped out, out-performance for stock
purchases are calculated by percent per day.
When index movements are stripped out, under-performance of stock short
sales are calculated by percent per day.
It is then determined if an edge exists. Is it stock picking,
is it in index direction prediction.
Is it for down moves of stocks or up moves of the market as a whole
...
Yes I have an edge/edges - how can I best exploit it/them.
Do I buy or sell or both. Do I take stock positions only or
index positions only or spread stock against the index?
Over what period does my edge fall away? What period is
required for my edge to show fruit?
Now I design a trading system based on all the characteristics of my edge
and my knowledge of my edge. My confidence is high but
not too high - I know the basis of the confidence.
I do back-testing some forward testing. All is
well.
I have done my risk of ruin calculations and I am comfortable with the
position sizing implications. I know the likelihood of four,
five six... losses in a row - I have the confidence to get past that into
profit and if necessary, by the work done for risk of ruin calculations,
I can recognise when my skill has probably gone.
I start to trade using a very small trade size, building up my confidence
step by step based on experience.
The Difference
One is based on my back-testing, and trading that back-testing with
enthusiasm, but little reliable confidence.
The other on identifying an edge, knowing about the edge, understanding
the edge, making the edge my own, designing a trading system around my
edge(s), doing back-testing, using confidence building techniques,
trading my trading system in the context of risk of ruin based position
sizing.
Which trader is likely to last longer, get more experience, get more out
of that experience?
More Questions
Which trader do you think is likely to bank the most money over the
medium and long term?
Which is going to exploit environmental changes and which is going to
fail though not adapting?
Which is going to make steady improvements and which is going to
ossify?
Which is more likely to fail, give up their trading system and is
destined to probably repeat the process, equally enthusiastically, with
the next trading idea.
Which are you?
What is stopping you from being the second type of trader?
Either nothing because you already are, or nothing if you put your mind
to it.
Trading with good feelings, Ric.
www.traderscalm.com
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