Wednesday, July 27, 2005

You pay the market for information

What I’m writing below is about 100 years old and still it is valid.
I’ve gotten the idea from “Reminiscenses of a Stock-Operator”. If you have not read one trading book, this one is a must.

In trading you make money by taking a position. As long as you demo-trade, as long as you study charts after the market is closed, you are not involved. You demo-trade because you want to save your hard-earned account balance until you are ready to trade, because you fear you will have to pay too much before you have learned to trade. And, of course there is nothing wrong with that, just that there are a lot of traders who could trade, if only they were able to leave the Demo-trading stage behind them.

But why do you have to pay too much?

STOP’S and it’s companion  CANCELLED STOP

So, you have a trading plan, you have setup’s which work, you have back-tested them, you have demo-traded them, they work. Still the moment you go Real, the S**t hit’s the fan and everything is blown right in your face. You don’t believe it. It can’t be possible, that the first trade you take after so much Demo-trading is the trade NOT working, is the trade going against you. Therefore, you cancel the Stop and, of course, it is the trend changing trade you took, it was the Top you bought or the Bottom you sold, and it just cost you more and more to accept defeat.

But there is a way out, there is a different way of thinking, which might help you to see the market a lot more objectively, which might be the emotional difference between having no problem of taking a Stop and cancelling the order, because you can’t believe it, that the market is doing this to you.

We all agree, that trading is all about probabilities. Say your trading setup has a 70% win rate. So on 7 trades out of 10 you should see your trade-setup work, on 3 you will loose on average. This means the probability, that your trade will go against you is 30%. Just mathematics, but once you open the trade these 30% weigh a lot more on your soul, than the 70% where the trade-setup is working.

But let’s take a different look:

Have you ever played poker or bought a lottery ticket? I’m sure the answer is YES. Both times you pay an amount of money to know for sure, whether you got lucky, whether you have the better cards or not. First it’s a probability, you have the chance to win, but after you paid for your ticket, for the right to see, you will know for sure.

You determine, that you have to use an 8 tick Stop to know that your Trade-setup is working or not. (If you could back this number by your statistics, where you analyzed a sufficient number of trades, just the better).

Trading ER2 that’s 80$/c. You trade 2c, so we talk about 160$.

So BEFORE you take the trade, you ask yourself:

Is it worth 160$, am I willing to pay the market 160$ to learn, whether this particular trade-setup is working or not. If the answer is NO, just leave the trade alone. Don’t look at this setup again, if it works or not, you decided, that it was not worth 160$ to learn about the truth, so that’s it. You don’t chase, you just wait for the next setup to appear and then you ask yourself the question again.

If the answer is YES, you take the trade, you set your stop, and if the stop is hit, it cost you exactly the 160$ you were willing to invest to learn about the truth.

For me, who always had a huge problem with stops, this opened a new world. I’m no longer staying in front of a freight train saying Stop and Reverse, I’m no longer jumping on a running train at full speed not knowing, if I have a chance to leave in case of emergency. I know in advance how much my ticket will cost me. The market is telling me with every tick, Chris, now it will cost you 100$, now 150$, now 200$ and now just 60$ to know if the trade-setup is working or not. The signal is there, but it is my decision to say, yes I’m willing to pay 80$ to know if this trade is working or not.

 

3 comments:

Globetrader said...

onlinefeedback, you already announced your blog in my last entry, so I think that's enough advertising

cometguy said...

Hi Croc,

Your point is well taken. Stops are just the cost of doing business, and keeping your losses under control. It doesn't matter what system you use, how simple or complicated it is, or whether it's intraday, swing or long-term. The market will do what it does, and you can only hope your "edge" works. Now I'd love to hear your thoughts on how to take profits; it's even harder than taking stops. Thanks for a great blog,
cometguy

little kernel said...

hm, this seems a little less like an intellectual financial foray, and more like an advertisement. I'm with globetrader. For those seeking real content, check out my blog at http://popcornandpeople.blogspot.com!