Message From TraderJanie
I’ve reviewed the 4 Traits you will develop in the Mechanical Stage listed in Trading in the Zone.to become a better trader. I promised to set up an exercise Douglas
has in his book, “to convince yourself that trading is just a simple game of probabilities (numbers).” You’ll be very pleasantly surprised that it is exactly what we do each and every day in the Member’s only site.
Setting Up the Exercise
Here is an exercise that any trader can perform to become a better trader. I am going to take the text right from Douglas’ book but unfortunately will have remove some since it is too verbose for this newsletter. Unfortunately, even with the deletions, it is a very long newsletter but well worth the read. I will add some of my own comments in italics.
The object of this exercise is to convince yourself that trading is just a simple game of probabilities (numbers), not much different from pulling the handle of a slot machine. At the micro level, the outcomes to individual edges are independent occurrences and random in relation to one another.
At the macro level, the outcomes over a series of trades will produce consistent results. From a probabilities perspective, this means that instead of being the person playing the slot machine, as a trader, you can be the casino, if:
- you have an edge that genuinely puts the odds of success in your favor;
- you can think about trading in the appropriate manner (the five fundamental truths); and
- you can do everything you need to do over a series of trades. Then, like the casinos, you will win the game and be a consistent winner.
1. Pick a market. – Choose one actively traded stock or futures contract to trade. It doesn’t matter what it is, as long as it’s liquid. (The algorithm filters for liquid stocks)
2. Choose a set of market variables that define an edge. This can be any trading system you want. The trading system or methodology you choose can be mathematical, mechanical, or visual (based on patterns in price charts). It doesn’t matter whether you personally design the system or purchase it from someone else, nor do you need to take a long time or be too picky trying to find or develop the best or right system. This exercise is not about system development and it is not a test of your analytical abilities. In fact, the variables you choose can even be considered mediocre by most traders’ standards, because what you are going to learn from doing this exercise is not dependent upon whether you actually make money. (Yup you already have this).
3. Trade Entry. The variables you use to define your edge have to be absolutely precise. The system has to be designed so that it does not require you to make any subjective decisions or judgments about whether your edge is present. If the market is aligned in a way that conforms to the rigid variables of your system, then you have a trade; if not, then you don’t have a trade. Period! No other then you have a trade; if not, then you don’t have a trade. Period! No other extraneous or random factors can enter into the equation. (Ya gotta LOVE this).
4. Stop-Loss Exit. The same conditions apply to getting out of a trade. Let the market structure determine where this optimum point is, rather than using an arbitrary dollar amount that you are willing to risk on a trade. In any case, whatever system you choose, it has to be absolutely exact, requiring no subjective decision making. Again, no extraneous or random variables can enter into the equation. (This is built into your algorithms).
5. Time Frame. Your trading methodology can be in any time frame that suits you, but all your entry and exit signals have to be the same time frame. (No problem here, we use daily charts)
6. Taking Profits. Believe it or not, of all the skills one needs to learn to be a consistently successful trader, learning to take profits is probably the most difficult to master. A multitude of personal, often very complicated psychological factors,enter into the equation. Unfortunately, sorting out this complex matrix of issues goes way beyond the scope of this book. I point this out so that those of you who might be inclined to beat yourselves up for leaving money on the table can relax and give yourselves a break. (When the cRSI hits a certain value you’re outta there.)
7. Trading in Sample Sizes. The typical trader practically lives or dies (emotionally) on the results of the most recent trade. If it was a winner, he’ll gladly go to the next trade; if it wasn’t, he’ll start questioning the viability of his edge. To become a better trader, we have to expand our definition of success or failure from the limited trade-by-trade perspective of the typical trader to a sample size of 20 trades or more. (This means you have to take 20 trades according to the system and not deviate from it.)
8. Back-Testing: Once you decide on a set of variables that conform to these specifications, you need to test them to see how well they work. (Well DUH!)
9. Accepting the Risk. A requirement of this exercise is that you defined your stop on each trade in your 20- trade sample size. As you now know, knowing the risk and accepting the risk are two different things. The potential risk is that you will lose on all 20 trades. This is obviously the worst-case scenario. It is as likely an occurrence as that you win on all 20 trades, which means it isn’t very likely. Nevertheless, it is a possibility. Therefore, you should set up the exercise in such a way that you can accept the risk of losing on all 20 trades. (This will be the hard one)
We’re the Plan in “Plan your Trade and Trade your Plan”
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