Category Archives: Trading

Twitter poll on expectancy

Trading Journal

I had put a poll on twitter yesterday with options to choose from various combinations of Winrate and Risk:Reward(RR)

Here is the twitter link:

44% of the voters chose Option 4, 32% of the voters chose Option1, followed by Option 2 and Option3 respectively.

Before getting into the groove of things, I would like to elucidate a bit about ‘Expectancy’ of a system. This term was coined by Van Tharp and here it is:

Expectancy = (Win rate x Average winner) – (Loss rate x Average loser)

If we insert this formula with the numbers given in the poll, We get the following –

Expectancy of System 1 = (0.5×2.2) – (0.5×1) = 1.1 – 0.5 = 0.6

Expectancy of System 2 = (0.7×1.2) – (0.3×1) = 0.84 – 0.3 = 0.54

Expectancy of System 3 (I meant to give the RR of system 3 as 1:0.8 but gave it as 0.8:1 – we will stick to what was given in the poll)
= (0.8×1) – (0.2×0.8) = 0.8 – 0.16 = 0.64

Expectancy of System 4 = (0.35×4) – (0.65×1) = 0.75

So, what is this expectancy? Expectancy is how much one can expect to make on the average over many trades. Expectancy is best stated in terms of how much you can make per rupee you risk. Tharp talks in terms of R-multiples but let us just focus on it in layman terms.

If someone risks 1% per trade and their system expectancy is 0.5, it just means that over a large sample of trades, he is expected to make 0.5% (1% x 0.5) per trade. So, if he has 100 trades in a year, he is expected to make (100×0.5%) 50% that year.

Surface level analysis of the poll results

1. It is quite obvious from the above calculation that higher the expectancy, greater is your chances of making money in the markets. So, as a new trader, it is pretty easy to select the option # 4 from the choices. No brainer there.

2. Few people pointed out that Option 1 is better as it is easy on psychology of the trader. It is true to an extent but if one is striving for better risk adjusted returns, option 4 is the obvious choice again (especially for a pure trend follower). Different people, different choices 😊

3. Some people take profits on the way and they would have naturally gravitate towards a better winrate system with lesser R:R. The traders who trail profits will almost always have a lower WR but better RR system in hand.

4. As I always advocate that there are various ways to skin the cat, nothing is right or wrong here. We just need to pick what is comfortable for us. But, if one has to analyse logically, it is option 4. On a side note, one comment mentioned that we need to find system that have a expectancy like the choices mentioned 😊. Fair enough !!

5. The traders who are new to the market gets enamored by the high winrate for a very simple reason – typically, they don’t want to take losses (Forget about newcomers – even the experienced lot do not like to take losses). Their mind can never get around in accepting the losses. So, they naturally gravitate towards high winrate as high WR typically means more number of winners than losers. But, what they forget is the other side of the coin – the Risk:Reward. They lose more when they lose and win less when they win. This has many statistical implications. We will see that in detail in the next section of this post.

6. Winrate and Risk:Reward should be seen together. They are like peas and carrots, day and night – always go together. This is why I like this expectancy as it nicely clubs both the parameters to give a logical view of the system in hand.

7. Few people have voted for option 3 as they feel high winrate can give them the psychological comfort – again, this is just another way of telling that ‘I don’t want to take losses’. As some great trader mentioned. ‘avoiding losses in trading is like you want to breathe in but don’t want to breathe out’. But if it works for you, great !!

In-depth analysis of the poll

1. Most of the stock market strategies employ trend following concept and the pure essence of trend following is to let the profits run. So, the detailed analysis is based on that assumption.

2. First let us dissect what High Winrate really means. Typically, a high WR system will have low Risk:Reward (compare to a low WR with same expectancy). This is a given. But, this also means that the average loser of a high WR system is usually larger than a low WR system(assuming the timeframe and expectancy are the same). In a trend following system, high WR is usually achieved by giving so much room for the market to catch the trend. Statistically, bigger SL will have a huge drawdown potential (am talking about maximum drawdown) and if the max DD is high, it is very difficult to proceed with the system for two important reasons –

a) The recovery factor will be high – meaning the number of trades it takes to get back to equity high(again) will be more and the problem exasperates if someone is trading higher timeframe. People grossly underestimate time drawdown – but it is a different topic altogether

b) Compounding can be a big problem for a system with larger max DD for obvious reasons

3. When a system has a bigger SL (again assumption is that we are talking about pure trend following systems with trailing stoplosses) like a moving average crossover system, the time the market spends between the entry point and stoploss is huge. This has so many psychological ramifications –

a) It can create havoc to our mind as it will feel that we are always in loss (even though it is not realized). One can draw analogy with an investor who enters a stock and the stock is underwater for 2-3 years. It is a very tough phase for that investor if he is still holding it.

b) It can force a trader to make mistakes (not following the plan) and just letting the emotions take the driver seat (how many of us have heard this ‘ I felt uncomfortable in the trade and got out but only to see the market moving in my favor again’). So, wider SL is a fertile ground for all these mishaps in the thought process.

On the other hand,if WR is less with smaller average losses, it will diminish the active trade time in grey area (between entry and SL) and give us a big advantage mentally.

4. Lesser WR and higher RR generally means smaller losses (compared to high WR and low RR/same expectancy system) and consequently, a trader can be well equipped for the proverbial series of losses in a row. One can place large number of bets or trades before we reach out max limit. So taking randomness into account, we give ourselves a fair chance to be in the game. Not to mention, these smaller SLs will also cap the maximum DD and will keep it nicely in control.

The below picture shows the 95% probability of losing streaks for various winrates. Even a 50% winrate system can have 16 losses in a row over 5000 trades. It is not a question of how but it is a question of when.

Workshop

5. On the flip side, Low WR and high RR will never have even distribution of profits as the system will turn positive only with large profits. If one misses those trades, then the performance would be pretty dismal.

6. The interesting thing is that most of us would feel better with a system that produces more winning trades than losers. The vast majority of people would have a lot of trouble with the 4th system (even though it has the best statistical advantage compared to other systems) because of our natural tendency to want to be right all of the time.

7. As I always say ‘there is nothing right or wrong’ in the markets. We just need to choose what is comfortable for us. The battlecry is ‘how to find the one that is comfortable for us?’. Very simple – try them all with minimum size. Your mind will naturally cling towards the one that is comfortable for you 😊

Happy trading !!

Law of Large numbers and its implication in Trading

Trading Journal

Besides loving to trade and playing cricket, I am an ardent subscriber to the statistical concept – the law of large numbers. According to probability theory, the law of large numbers is a theorem that describes the result of performing the same experiment a large number of times. Moreover, the average of the results obtained from a large number of trials should be close to the expected value, and will tend to become closer as more trials are performed.

Let us look at some illustrations first before talking about its implications in trading.

Law of Large numbers and Coin toss

Law of large numbers is best illustrated by the example of a coin flip, which has a 50% chance of landing on heads. If we flip the coin twice, we have almost exactly equal chances of any scenario happening: heads twice, tails twice, or evenly split. The probability of getting 5 heads and 5 tails on ten flips is just 8% but that probability keeps increasing as we increase the sample size. If one flips the coin 100 times, the probability of getting 50 heads and 50 tails (P=0.5) increases to 70% and so on.

Below is a depiction of the Law of Large Numbers in action, for 1000 trials –

Workshop

As one can see, the more the sample size (trials) is, the probability of getting equal number of heads/tails increases.

Law of large numbers and casinos

Coin flips are interesting theoretically, but the Law of Large numbers has a number of practical implications in the real world as well.

A famous example is Casinos – who can forget the ringing sound of slot machines/clamoring laughters sound in the craps table of Casino halls. Casinos live and die by the law of large numbers. Each game has a house edge built into it, representing the average loss over the initial bet. Some sample edges are –

* Blackjack – 0.75%
* Baccarat – 1.2%
* Craps – 1.4%
* Roulette – 5%
* Slot machines – 5-10%

Over longer time frames, it becomes increasingly likely that the house edge will represent the casino’s profit margin.

Law of large numbers and trading

When it comes to trading, many misinterpret(in a negative way) this law of large numbers. They think that the more they trade, they would have more losses which leads to account blow-up. If a traders’ methodology has a statistical ‘edge’, and if he does not change the underlying parameters on the way, it is better for a trader to let the law of large numbers to work in his/her favor.

Trading decisions may appear to be binary – either buy or sell or up or down, but they are not. There are a critical variables which must be accounted for, such as how much am willing to lose/how to trail the profits, or in other words, what is the risk/reward of the trade and how do I manage the trade. So, there is something other than chance that comes into play when trading, and that is skill and technique.

It stands to reason then, that the better your skills and technique, the more you should trade. While Law of large numbers is important because it “guarantees” stable long-term results for random events, it follows that it is also important that our sample of trades is large enough to maximize the number of successful outcomes from our skillful trades and therefore maximize your earning potential. So, if it sounds so simple, why does traders do not allow this law to work for themselves? Why do they jump ships on the way(changing trading systems)?

Think about this for a second. The trader starts trading their plan with all good intentions. Things may or may not go well straight away, but sooner or later as the markets behavior ebbs and flows with/against the strategy’s strengths and weaknesses, losing trades will inevitably occur. At this point of time, the trader gets scared. They don’t like to give money back to the market, so they decide to try and modify the system to filter out trades like that last losing one. They begin to add indicators to charts, coming up with new ever more convoluted combinations, furiously testing to see what cuts out the most bad signals while leaving in place the good ones. A few times round this loop and suddenly, their chart starts to resemble something a seismologist might be more used to seeing than a price chart 🙂 As a result, again, the loop starts – they never let ‘law of large numbers’ to work as they dont stick around with one idea. Law of large numbers will be rendered meaningless if we keep changing the rules on the way.

Law of large numbers and behavioral difficulties

To let the law of large numbers work for us, we need to put trade after trade, over and over again without changing the underlying parameters. Just like onerously bolting on wheels on an automobile assembly line, making a series of trades can be very tedious. It may be hard to maintain self-control at times. It is understandable. We are human, and humans have a strong primal urge to seek out drama and action.

The kind of person who is attracted to trading is not the person who prefers tedium to excitement. This is the raw fact. If we are a trader, we’re probably the kind of person who has shunned a mundane 9-to-5 job for a more unconventional, adventurous profession (many come to trading for this reason). The excitement of working as a full time, active trader appeals to us. We thrive on the uncertainty and endless possibilities. What attracts us to trading, however, may also be a reason for our downfall, unless we are careful. We may be the kind of person who gets bored easily. It is quite possible that the long hours of self-control required to make a profit may be difficult to maintain. This is why many crave for action in the markets. So, eventually, they put on trades that is not part of their plan. It is exactly at this juncture, we break the ‘law of large numbers’ as it assumes that we do the same kind of trades(based on a definite idea) day in/day out. Essentially, we never stick around (or stick around with the same idea) for law of large numbers to work.

How to gain from Law of large numbers

It would be prudent if a trader(new and experienced alike) does the following –

1. Create a trading plan
2. Backtest the plan with large sample size (never fall victim to small sample skewing)
3. Determine your risk based on backtesting parameters
4. Create a money management plan
5. Stick to the plan to let the law of large numbers work

Final thoughts

It is illogical to subscribe to the theory that ” you’re only as good as your last trade. ” If you are going to trade for a living, there is no last trade, only the next trade. Whether, our last trade was a winner or a loser, it has absolutely no bearing on the outcome of our next trade.

Unlike gambling, a winning streak by a trader will NOT eventually be overcome by the parameters of the game, unless he somehow convinces himself that this is his inevitable outcome. Trading is not gambling where the house has the edge (let us not focus on the broker’s commission and negative sum game for a moment). Trading is a performance based activity that requires skill, technique, experience and above all, practice. Most important though, the trader must have the right attitude, focus, patience, and self-confidence, and then the trader will be the one who possesses the edge – not the other way around 🙂

Happy trading !!

Social media and its impact on the mindset of a trader

Mentoring

I have been active in Twitter for the past 6 months and this side of world seems to be filled with overly-expressive folks, especially, when it comes to trading. Traders bicker with each other like kids for everything under the roof and keep fighting that their method is the best in the markets. Even a 5-year experienced trader knows that there are many ways to skin a cat and one method is not superior to other.

Open disclaimer first – right off the bat, it may piss some people off but in long run accepting and learning to deal with these basic tenets will definitely help us to move into the small realm of successful traders. Please adopt the supermarket approach. If you don’t like something in this post, please ignore this rambling. This post is not intended to hurt anyone as I do not know 99.99% of the traders in-person. So, not directed to any individual or group. The pointers that are covered below are few of the several reasons that hamper a trader’s progress if he is active in social media during market hours. Whether you are involved in bickering/ego-fighting or just a spectator, the end-result is same, albeit with varied intensity.

1. When one is trading profitably and wishes to teach it to others (the psychological urge behind this teaching could be many but let’s stick to the point), he cannot expect his students to understand it the same way as he has understood. As it is almost impossible to convince a bear to be a bull once he or she has taken a position, it would be even more unfathomable to convince each trader to trade a certain way. I also conduct workshops and I don’t expect my participants to understand the mechanics of my trading style in a day. Once they keep practicing the concept, it might get internalized well in the mind (after dedicated practice) and the idea can open up many possibilities.

While we are at it, would also like to mention that just because we don’t understand a method, does not mean it is not making money for others. ‘Lack of understanding’ cannot be construed as the ‘failure’ of the method discussed. On the flip side, there are 100’s of ways to make money in the markets and it would be childish of us to ridicule other methods. It would be more childlike if we say that my method is superior to others and start chest-thumping – this is so prevalent in facebook/twitter unfortunately. Market returns are cyclical and method A might do better in certain circumstances than Method B – vice versa is equally true. Please understand that everyone has different time frames, methods and objectives. It is also prudent to remind oneself that “every dog has its own day

2. Stop justifying your methodology or trades – who are we are trying to prove here? We don’t need to prove anyone that we are successful in anything. So, why to some strangers? If one is successful in trading, he will exhibit patience as patience is every successful trader’s virtue – without exception. Patience comes with a sense of calmness and confidence. You know you are doing the right thing. Thus, there is no need to justify excessively. On the other hand, stubbornness often comes with anxiety and over-justification. When you find yourself trying too hard to explain what you are doing, you are being stubborn.

Any successful trait needed for trading (like patience, emotional control and discipline) will definitely be reflected in our other aspects of life too. Our family/friends would definitely see the massive difference once we become successful (not only in our finances but also in our behavior) – One of the important perks of being successful in trading.

3. Actually, most of the traders know the reason (or set of reasons) that make them lose money in the markets. But taking corrective action and doing the right set of things to turn profitable is something that individual has to do. Please do keep in mind knowing, and doing are two very different things

4. While people are told they won’t be successful overnight, most new/struggling traders don’t actually believe that. Social media never lets them believe it completely as every other trader is supremely successful in social media 🙂 They have an idea in their head that they’re smarter (Lake Wobegon effect), have it worked out, and will be able to make money quite quickly. So, always in the urge to make money faster and lose it actually.

5. As Master Oogway tells in the movie Kung Fu Panda “One often meets his destiny on the road he takes to avoid it.” (this quote is actually from a french poet Jean de La Fontaine). Most of the traders are determined not to lose money (rather than having a determination to ‘make money’) and in the process, they actually lose more money. Am not saying we are pre-destined to results but this one needs to be taken seriously. Knew many folks who have the aversion for loss and unfortunately, end up in trading (trading needs that loss digesting stomach) and struggle for years.

6. False hope also keeps our enthusiasm going in trading. We can attribute this ‘false hope’ to survivorship bias – We are likely to hear more stories of people making a killing than hearing about people losing everything because the people who lost everything are gone from the public eye and are not talking about it. The few who make money are sure to let everyone know about it (or others talk about them a lot) and thus create a sort of illusion–intentionally or unintentionally– that anyone can do what they did/do.

7. Easy money lure – the lure of making money each day in only a couple hours gets people’s minds spinning with possibilities. They imagine stopping everything and just start trading for a living immediately (For example, lot of chatter happened on Sept 21 2018 EOD about people buying far OTM puts for pennies and selling it for 200s..this kind of chatter happens a lot when mkt moves violently..this also feeds the mindset that money is easy in trading)

As a matter of fact, they would start dreaming about trading in a beach while sipping pina colada. Unfortunately, sand, water, sun glare and laptops don’t mix. You are not gonna get paycheck every month and you must be absolutely at the top of your game without distractions to make money long-run (this is exactly why I keep advocating to get off from social media/forums during market hours). Distraction and ego fights can damage our psychological forte and eventually, we start focusing on things that does not matter.

8. Long story short – stick to a well-defined plan and trade that plan even when it is uncomfortable (and it often will be). The vast majority of the population, and thus the vast majority of traders, buckle under this uncomfortable pressure – the same way we reach for the ice-cream instead of the carrots.

9. On the other side, social media and forums can have a positive/lasting impact on a trader if he can figure out a virtual mentor(mentor does not have to know you but you can follow his principles/thought processes). It can be a great resource of authentic information for new traders as well. But overall, it has never served a trader well if he loiters around in social media during market hours. This is not even debatable any more as the negatives over-weigh positives by a huge margin.

10. So, if you are a losing/struggling trader, try getting off from the forums/social media (for few months) during market hours. See if it has changed your overall mental resilience/trading. I can bet that this will be a great trade to put on as Reward:Risk seems very high. Risk = not being able to participate in conversations/getting updated about latest news, Reward = profitable trading without outside distraction.

Happy trading !!

Trend following and pivots basics

Introduction

When it comes to trading the markets, we are always inundated with so much of information (I call it as ‘Information constipation’) that we could no longer see the forest but obsessed with just seeing the trees. The process of trading or speculation (as they call it), has morphed into a pseudo-intellectual science and consequentially, traders think that they must strain their brains to profit. Trading, however, is anything but an intellectual exertion. In fact, the more we use our brain in trading, the more likely we are to find ourselves with negative P&L.

I have actively traded my own account for the last 12+ years and let me be honest – the initial few years were marked by lots of trial and error. A good mentor can obviously shorten that learning curve but that is besides the scope of this post. Becoming a consistently successful trader has got nothing to do with education and I can vouch for it. My success in trading has got nothing to do with my postgraduate degree. In fact, my formal schooling did more to hinder my ability to trade than help. Graduate school filled my head with lot of abstractions and theory but did nothing towards advancing my common sense. It caused me to think a lot about the ‘right way’ to trade, and the harder I thought, the farther I was going away from the basics of trading.

Trading is not so fundamentally difficult, but the print/visual media wants us to feel so. They have their own business reasons for it. Trading the markets can offer fantastic opportunities to make money but it is at the same time, the most self-revealing career anyone can ever choose. Now, one may wonder why this rhetoric but think about it. If any of us can structurally identify what the markets are doing currently rather than trying to ‘predict’ what the markets are going to do, job is 75% done. We don’t need to predict as we don’t know ourselves what we would be thinking this time next week. Neither can anyone know what the markets will be doing this time next week. We all trade our own belief systems. Once we identify the underlying structure of markets, suddenly, trading seems not that difficult. This is where ‘structural pivots’ can be of immense help. Pivots can help us identify the path of least resistance. Think of how, in our own life, we follow the path of least resistance. Following that path has led us to read this blogpost this very instant. Just understanding the underlying structure of the markets has served me well in the past decade.

Floor pivots vs structural pivots

Whenever I use the word ‘Pivot’, the listener always gets baffled on what I really mean as we have another set of pivots that is often talked about. This section is to clear that up a bit.

There is something called ‘floor pivots’. Floor pivots has been used for many years by floor traders to come up with a reference point based on the prices from the previous day. It is calculated based on high, low and close of the previous day. And few lines are drawn above the pivots as resistance and few lines below as support. Most of the technical trading platforms can plot these lines automatically.

The formula is as follows:

Pivot = (H + L + C)/3
Resistance level 1 =(2*P) – L
Support level 1 =(2*P) – H
Resistance level 2 = (P – S1) + R1
Support level 2 = P – (R1 – S1)

I personally find these levels not so useful for trading. Some people think that these levels have meaning because so many floor traders, and now screen based traders, watch them, and they become self-fulfilling. That may be true to some degree. On most trading days, there is no beneficial information at any of these levels. Many attempts have been made to change the formula, such as using the current day’s opening price instead of the previous close. There is little improvement with any of these variations, in my opinion.

An interesting experiment is to draw a line randomly on an intraday chart. Just close the eyes and drop a line using a horizontal line tool and place it anywhere on the chart. Then, watch as prices move away from or toward this line. It will hit and reverse on the randomly drawn line about the same percentage of times as it does off the pivot or the support or resistance levels. The randomness of the placement of the line does not necessarily make it useless. A line drawn anywhere on the chart can be a useful point of reference. With a line on the chart, one has a better sense of the market movements. You can more easily gauge the movement, or acceleration towards or away from this line. It is like being in a boat at night, in a fog, with a lighthouse at some distance away. The lighthouse becomes a point of reference, and you can tell whether you are getting closer to or further away from that point of light.

On the other hand, a structural pivot is a price level that stands out on the chart as a high point and surrounded by lower bars, or for downtrends, a low level that stands out and is surrounded by higher bars. For example, in an uptrend, a price level will be reached that attracts selling and shuts off buying, at least momentarily. Prices will usually fall back somewhat, thus leaving a price bar on the chart that has lower highs on either side. This high price bar then becomes an area to test on the next push higher. Traders mark the structural pivots in myriad number of ways and I have found my own way of marking that helps me understand the underlying structure of the markets in a more systematic/structured way (this will be covered in the first session of my upcoming workshop in Bangalore/Chennai). Pivot points on the chart create excellent reference points to interpret the developing market structure. Some traders refer to these pivots as swing points. Those who view the markets in terms of chaos theory would refer to them as fractals. They are all same concept, just with different names. This way of marking structural pivots has been around from early 90’s.

Trend following and structural pivots

Trend determination is obviously important for trend followers, but anyone trading in any style should be aware of the trend in the market they are trading. The overall trend can influence our trading style. The beginning of a trend can be easier to trade than end of a trend in many cases. Therefore, it is important to know what the trend is.

But to complicate matters, there can be many trends at play in the same market, even on the same chart. There are trends within trends. Different period lengths on a moving averages, or indicator input, can signal a different, often confusing and conflicting trend. There can be a counter trend down move on a 30-minute chart, while the daily chart is showing a powerful uptrend, while the monthly chart is showing a sideways trend. When they all line up, it is the most comfortable and reassuring time to take a trade, but if we wait for everything to be in sync, we you would probably trade very little, and often not in a timely manner (this is a common problem with ‘multi timeframe’ analysis’) And often the comfortable and easy trade is the one everyone sees, and it often turns out to be untimely. My thought, after changing my mind on this issue many times over the years, is to keep it simple and just trade off the time frame of the chart you are analyzing.

Most of us want indicators to guide us, as indicators are quantifiable. We can lean on them with more confidence. However, the purest and fastest way to determine trend is just through studying the price structure. Price does not lag. Price is not derived from anything. It is current. It might frustrate, but it doesn’t lie.

Workshop

The above chart shows a series of price bars. I took the time frame and market off the chart for this illustration. It really doesn’t matter what time frame is being analyzed. A trend has the same basic structure in all time frames. The red and green horizontal dotted lines are placed at swing points in the price action.

This is the same theory of a market making higher highs and higher lows, although this isn’t always exactly true. Sometimes a pause will form in the price structure and prices temporarily go opposite to the trend with the market making a lower high, but as long as a lower low is not taken out, the uptrend is still intact. On the above chart there is a smooth progression of structural points taken out from the first blue up arrow to the red down arrow on the right. There was only one instance, near the middle of the chart, where there was a slightly lower swing high.

I believe swing points are valid as a breakout strategy because the market views these points as areas to test. If the test fails, the market will test or create a swing point in the opposite direction. If the test is successful, the market will proceed upward, and the old swing point becomes an area of support if the market revisits that neighborhood. The market is constantly testing whether trade is accepting or rejecting price, and these structural points are the reference points for these tests.

Workshop

So, what do we do when the market chops like we see in the above picture? There is a way of avoiding these chops atleast 60% of the time if we mark the large pivots (see it as a high/low of a range) on top of the small pivots and trade only if it goes beyond that range. I have 100% mechanical way of marking it, formed rules around it which can be traded mechanically. Most of the structural pivot traders imbibe an element of discretion in their trading (to avoid chop trades) but that is exactly why, those traders suffer the most w.r.t psychological let-downs of the mind.

I should also mention that another trend following approach that was very popular in the past. It is the channel breakout. It worked in a very narrow window of time when markets trended well. The basis of this approach is to buy the breakout of the high of x number of bars ago, or short the breakout to the downside of the low of x number of bars ago. Often a stop is used with the same breakout method, but with a shorter look back period. One of the originators of this method, who was incredibly successful for a time, has not been able to be profitable with it in recent markets, even after many attempts. I think a more valid approach using breakouts is to trade the structural pivots, rather than a fixed lookback. The pivots are dynamic and reflect the structure of the price action. Fixed lookback periods don’t offer a breakout related to market structure. The market is testing structural points to see if price can be accepted or rejected at these points. The market doesn’t care about testing a price bar that occurred 21 bars ago just because it was 21 bars ago.

This has been a long post but I feel a much needed one as I often get questions on what pivots are and how to make a price action idea 100% mechanical in nature (with unbending set of entry/exit/MM rules). That is exactly what I intend to do in my workshops on August 11, 2018 at Bangalore and August 18, 2018 at Chennai. I will be showing how to identify and mark the pivots, how to mark ranges (mechanically), how to create entry/exit rules for this concept that can be traded mechanically and how it has served me well so far

Happy trading all !!

Price action trading workshop – Topics

Trading Journal

Received few queries on what would be the topics discussed in the 1-day PAT workshop and here is the probable list –

Morning session topics – the trading strategy

1. Why price action based trading?

2. Market structure – Basics

3. Rallies and declines

4. Details of swing pivot high/lows – how to mark them mechanically (to avoid subjectivity)

5. Trends – what constitutes the trend

6. Analyzing trends based on price action swing pivots

7. Positional mechanical strategy with set of mechanical(rule-based) entry/exit rules

8. Intraday strategy with set of mechanical (rule-based) exit/entry rules

9. Trading results of both positional and intraday strategy – How it has made money consistently in the markets

10. Useful price action tips and tricks to extract more juice from the markets

Afternoon session topics – executing the strategy to trade profitably (albeit consistently)

1. What is an ‘edge’ in a system? How to quantify an ‘edge’? Do I really have an edge in my system?

2. How to efficiently backtest a strategy – what to look for and pitfalls?

3. How to evaluate backtesting results to create a money management plan?

4. Money management in trading – how to tailor made money management based on the backtested results?

5. Trading journal and its importance

6. The real holy grail of trading – Execution

7. Part time trading vs Full time trading – Differences and their effect on our P/L

8. Role of psychology in trading – Everybody talks about discipline/patience but how does that relate to trading success.

Pre-requisites

–*None*–

Who can attend

Anyone who wants to learn price action based trading for both positional and intraday trading

Have more questions?

Please email your questions to marketswithmadan@gmail.com or Whatsapp 96770 36689

Trading journal – why should a trader maintain it

Trading Journal

Introduction

Journaling our trades or in rudimentary terms, record-keeping is simply recording the trades with different set of values but it is not as simple as that. Now, I can hear some voices – ‘What is the big deal about journaling my trades? I have the best method in the world which is raking in 10% profits per week and so, I don’t need them” Fair enough. Happy for you!!

But, for regular traders (who do this for a living), a trading journal is probably the most important tool a trader needs to possess in order to trade the markets profitably. Proper record keeping can tell us what we have been doing right, what needs to improve and help find patterns in our method/behavior.

Maintaining a trading journal might sound unpretentious but even getting started, is an arduous task. First of all, most of the wannabe traders do not journal their trades. There is a strong reason for that behavior. If we keep a journal, then we will be forced to take responsibilities for our actions in trading rather than blaming the market, blaming others (eg: market makers, software glitches, hot social media guru, TV analyst), wife, neighbor’s dog and myriad number of illogical reasons. Records keep us honest and remember, numbers don’t lie !!

Key aspects of a trading journal

It is absolutely astonishing to know the kind of information traders can get from their journals if they include basic statistics about their performance. Trading predispositions that escape normal notice suddenly stand out when summarized statistically. With statistics, we can not only say that a trader made improvement, but can actually measure that improvement and track it over time. Such statistics capture improvements that will eventually show up in the profit/loss statement, but it may not be evident straightaway.

1. Observation about us and markets – It should have observations about us/our trading and about the markets themselves. I have found that trader journals usually are lop-sided toward self-analysis and include little in the way of market observation. When I began as a trader, I printed out daily charts of each day’s action and wrote comments on these, pointing out the patterns that I wanted to watch for in the future. After some time, this identification of pattern became automatic and it became easy to trigger that trade next time.

2. Observations about our best trades must be included – Many traders use the journal as a means of self-criticism or a venting out mechanism, and they only journal when they’re having problems in the market. Additionally, it should also tell our best trades so that we can focus on them more.

3. Journal should outline specific steps for improvement – It is not enough to write ambiguous generalities, such as ‘I need to hold my winners longer’ or ‘I need to be more disciplined’. Identifying specific steps we will take to hold onto winners (proper setting of trailing stops (if any), self-control strategies, etc.) or maintaining discipline (risk management, taking breaks, etc.) makes the journal a game plan for the next day/week/month. Such review is an essential step in the kind of continuous improvement that marks winners across all disciplines.

4. Net points and Average point in losing trade/winning trade (Risk:Reward) – self explanatory metric

5. Number of winning and losing trades

6. Winning ratio – this is one of the most beaten down parameter to lure newcomers into trading workshops/services and many others. This parameter is of no use if we don’t see it along with Average Risk:Average reward. A system with 30% winning ratio and 1:7 RR is much more superior (w.r.t risk adjusted returns) than a system with 75% winning ratio with 1:1.5 RR

7. Number of long and short trades – Some people are so smooth in taking short trades but they have hard time taking longs. This is a real problem for lot of newbies.

8. Time holding losing trades versus winners – It is very hard to make money over time by holding onto losers. Eventually, the size of the losers becomes greater than the winners so that even a trader who has more winning trades than losers can end up in the red.

9. Profit/Loss broken down by long and short trades and in-turn, broken down by market condition. This is particularly useful for discretionary traders. It tells them if they trade ranges better than breakout movements. If a trader’s performance is ominously worse in one mode than another, then it is time to start probing their trading for needed improvements.

10. Drawdown percentage (both average and maximum)– to identify the drawdown and see if it matches with the system’s expectations

11. Tracking emotions before/during and after the trade – Jotting down our emotions when we enter the trade, when the trade starts going in our favor/against us, stop outs and profit tgts(if any)…we will feel very different emotions in each of these stages. Identifying them (being aware) is the first step to understanding it. Over a period of time, the emotion patterns starts to repeat and we can really work on them.

12. It should have ‘entry note’, ‘exit notes’ and ‘what would i do differently’ columns for every trade taken.

13. It should have provision to subtract the commission+other taxes we pay irrespective of winner or loser.

14. Equity curve – nice equity curve graph is a must and a breakdown of monthly/quarterly points/returns in a pivot table

Probable learning out of a trading journal

When we see the metrics, we could see where we can work on (few areas of improvement) –

1. Holding onto losing trades as long or longer than winners – so, jotting down the time in a losing trade/winning trade helps here (Point # 8 of previous topic)

2. Significantly different profitability during morning vs. afternoon trading hours – this is applicable more to intraday traders. Many a times, fatigue can make an intraday trader go below his desired potential.

3. Different profitability during different market conditions, such as trending markets or volatile ones – there are 4 kinds of markets trending volatile, trending non-volatile, rangebound volatile and rangebound non-volatile

4. The tendency to give back the points of many profitable trades in a few large losing ones – this is the biggest sin a trader can make while formulating a system. Small losses/small profits/large profits are all OK but large loss is never OK for various number of reasons.

5. The trades and their distribution/sequence can teach us a very important lesson – not only markets and volatility are cyclical in nature, even returns are cyclical in nature. A stellar year can be followed with a lackluster year and the 3rd year could be an above-average year. This kind of understanding would give us the conviction to stick to the plan every single day.

Final thoughts

More than a tool, journal can be a great friend to a trader – they can remind us of what we’re meant to be doing. They are a way of focusing on process, rather than anchoring our moods and self-esteem to the ups and downs of P/L.

In the end, trading journal can be thought of as an exercise equipment – they only produce results if you work them regularly. So, let us start journaling our trades the right way and at the end of the day, let us be better traders. Atleast, we owe it to ourselves that much !!

Reasons and lessons behind blowing up trading accounts

Mentoring

“Blowing up” means we took the account down to basically zero, where we couldn’t place a trade any longer, or something similarly distressing.

As many of you know already, I have blown up a couple accounts in my days. None for many years thankfully, but it has happened. I view it as part of the learning experience, and naturally in hindsight it would be very easy to see why I blew up, and that I deserved it.

We can’t expect to make poor trades and be consistently profitable. Blowing up an account (no matter how large or small) isn’t necessary to become successful, but it has a tendency to smack us on the head with reality. It also seems to separate the pretenders from the contenders.

If we are willing to evaluate the damages after blowing up, then regroup and come back to attack with the new knowledge gained, we’re on our way. There’s no guarantee of success, but we’re a step closer than we were before. Like the old proverb says – “A man who wishes to travel a 100 miles should consider himself halfway at 90 miles.

Let us stick to the point here for a moment. There are numerous reasons for blowing up an account and I would like to highlight a few here.

Reasons for blowing up an account

1. Trading without stoploss

I can still clearly recall several times in my trading career where I thought I had solved the puzzle, and literally unlocked the mystic gateway (holy grail) to making money in trading. During those times, I would repetitively see the price hitting my SL and atleast come back to original entry point(or move into profits). This created a new connection in my brain and the next time the trade goes near the stoploss, I would gladly remove(or move the SL away from the entry further) the SL as market has a tendency to come back to breakeven point. Boy, I was so wrong. This can be brutal to the trading account.

2. Focusing on potential gains and not potential losses – ignoring risk

When we do focus on potential gains and not on potential losses, we tend to trade bigger (by usually using more leverage and not necessarily more capital) or risk more to get those desired returns.

Those who focus on making as much money as possible while ignoring risk will invariably lose the majority of their accounts. No matter how talented we are, we will face ruin, just as Jesse Livermore did and Victor Niederhoffer did on several occasions. Even the best traders like Alexander Elder and Nicolas Darvas blew up accounts when they first got started. Why? We simply can’t out trade the risk of ruin. If we risk a consistent 10% of our initial starting capital per trade we are done after just 10 losses. Everyone who has traded for any length of time has had ten losses in a row. If we risk 1% of our total starting capital per trade, 10 losses in a row will only bring us down 10%.

3. Not tracking the trades

A trader executes a strategy (usually not well-tested) and accumulates losses due to standard drawdown. But, without a trading journal, it is almost impossible to know where we are or are going, if we have no record of where we have been. I strongly believe one of the best things a trader can do is start keeping a journal.

Unfortunately, this does not seem to be the case for most of the traders. In the process of selecting candidates for mentoring, I had talked to at-least 60 people and the common theme among these budding traders is that they never maintain a history of their trades.

Lessons learned from blowing up an account

1. Taking responsibility for our actions

What I learned during these painful events was that I was wrong. I took responsibility. That is the first step.

Taking responsibility is the key. Accepting that we (temporarily) failed, and that we don’t know everything. From there, we can start building a solid foundation. We should be asking questions like what happened and why. This isn’t so much about investigating specific trades, but instead analyzing our overall behavior.

For example, did we bring a new methodology from forums/twitter without fully testing it? This is a difficult lesson to learn, particularly because most people simply don’t know how to properly test. So then, we would have to acknowledge we didn’t test properly (if at all), and go about learning how to do that.

2. Maintaining proper risk management

Another very difficult lesson was that we can be right about a trade, but still lose money. The market can remain irrational longer than we can remain solvent. This lesson involves learning about risk and proper money management, so that when we are in a bad trade it doesn’t do crushing damage to our account.

A key lesson is that we must live to fight another day. The single most important factor in trading is survival. The longer our survive, the more experience we gain, and eventually given enough time that experience will become valuable by providing we an edge over all of those with less of it.

3. Recording the trades – Trading Journal

The lesson we learn from the journal is not about recording our trades and screenshots, it is about learning our behavior. We must routinely go back and analyze what we have written, identify mistakes and patterns. Learning about our strengths and weaknesses in an objective way is crucial, so that we can then further develop in those areas. It is critical to be honest in our journal. It is important to talk about why we made a trade or decision, not just list the entry and exit price. It will also be helpful if we record our emotions during entry, while in the trade and during exit. This would clearly demarcate our emotions during those times and would reflect back on which feelings are overwhelming us and when.

4. Get out of simulated(paper) trading

Many aspiring traders sit on simulated environment (paper trading) for a long time – sometime months and even years together. I always advocate that paper trading is virtually worthless as a learning tool (unless it is done to understand about the trading software nitty-gritties) and when I unequivocally put that point across, people can’t reconcile that thought easily as it directly undermine their dream of becoming a successful trader one day.

The fact is, the majority of people are not good traders and are not cut out to make it in this business. It is a very harsh reality, but there is no denying it. Unfortunately, everyone thinks they are the exception to the rule.

If we want to be the exception to the rule, then we have to be put ourselves in a competitive position. That means being sufficiently capitalized, and having sufficient real trading experience (again, paper trading does not count).

You don’t have to take my word for it. Everyone that goes from paper trading to cash loses money, no matter how much of a rock star they were on paper trading. It’s my belief that the longer we are on simulated environment, the worse we condition our mind for bad behavior and thus the more likely we are to fail as a real trader. Again, you don’t have to take my word for it, it has been proven countless times before.

The entire point I am making — paper trading is not trading education. The real education is obtained once we start trading cash. We do not need to risk our monthly salary. Just start by risking a small amount and get off that orgasm-inducing paper trading.

Final thoughts

When we blow up an account, it is time to ask tough questions to ourselves – are we willing to commit the time (and money) that this profession takes to succeed? Look at it like any other profession. We need years of dedication and experience to become successful and even then, it still doesn’t happen for everyone.

When we have a stake in the game, it is completely unlikely what it seems to be when we are just watching it. We will find that trading is mostly about the acceptance and management of risk, and the management of our own reactions when we have money on the line, and are either making it or losing it. Both success and failure have their own psychological/emotional pressures, both can garble our judgment, and learning to handle the issues that both give is probably more than 90 percent of what real trading is about. The things that we are able to learn by studying the market are about 10 percent of the puzzle, if that. Really.

Happy trading all !!

Trading Q&A – Discipline

Mentoring

Someone asked me a question on ‘how to be disciplined all the time?’ and there was no easy answer. He was disciplined in following his plan most of the times but could not do it 100%. Tried my best to address this typical mindset.

Here is the question (quoting it) and the complete reply-

Question:

“Is/was breaking system/method rules a problem for anyone here? How did you/do you plan to overcome it? It is a problem I struggle with often, I have many days when I dont break rules and suddenly, the gambler in me, the tuktuk in me all get out on a single day and try to destroy my profits. It is not a continuous thing, I do follow rules most days, the gambler and tuktuk guy remain suppressed until one day they rear their ugly heads. Would be great to get some help in overcoming this failure in part, almost feels like a character flaw”

Answer:

We all go through this from time to time. If a trader is disciplined 90 pct of the time and if occasionally there is a lack in trading discipline, the reasons could be multifold —

Probable causes of the problem:

1. Lack of fit between the trader and the trading system

Discipline problems are not due to trading woes. Usually, there is an underlying problem. Just as a problem maintaining the “discipline” of monogamy in a marriage is frequently the result of underlying relationship difficulties, failing to be faithful to one’s trading plans is often a sign of conflict between the trader and those trading plans.

When traders who are normally disciplined find themselves breaking their trading rules, the momentary lack of discipline are a symptom of a lack of fit between who the traders are and what their rules demand. A fine system on paper is unprofitable if it cannot be followed by a trader. A trading method not only needs to be good; it needs to be good for the trader. A trader and a trading system should be like lock and key – it should be a perfect match !!

2. Trader trying to fulfill his short term needs

Sometimes, the lack of discipline involve failing to take trades that are indicated. Other times, the problem is one of overtrading – taking trades that lie outside of one’s rules. If we think of momentary lack of discipline in other areas–cheating on a diet, for example, or procrastinating on work that needs to be completed–we can see that, many times, we act against our longer-term self-interest by becoming caught up in shorter-term needs. If, for example, we cannot tolerate boredom, we might eat to fill the void and break our diet.

Solutions

Problem # 1

Keep a journal and truly investigate each of your small trading discipline slips. Then view those slips as information, not as problems. What do they say about you? Which rules do you find yourself breaking, and what is actually conflicting with those rules?

Now look at your trading successes. What came naturally to you? What rules and plans can be derived from those winning trades? Don’t force yourself into a pre-made set of trading plans (usually derived from somebody else’s plan) but rather, identify what you do when you win and see how you can make *that* into your system. This is one of the primary reasons why ‘copying’ someone’s system never work in the long run.

Problem # 2

When discipline works, it’s often because people have found constructive ways to meet those short-term needs. The smoker who craves a cigarette may chew gum as a substitute oral activity.

The key to sustaining discipline is to identify the specific short-term needs that are occasionally overshadowing trading rules. Once you’ve made that identification, it is easier to then brainstorm constructive ways of addressing those needs. Traders who overtrade, for example, often have problems during quiet market times. Their needs are for stimulation. By creating stimulating activities during the trading day that don’t take them away from their screens, they can avoid using unwanted market activity as their stimulation.

Other times, traders fail to follow their rules because they don’t truly have confidence in their ideas. They front-run their own signals out of anxiety and wait for perfection in setups before they act. Their short-term needs often are for safety and security – they need to believe in what they’re doing. Very often this problem occurs when traders have short-circuited their learning curves. They are putting meaningful capital at risk before they’ve done small real-time trading that is needed to build a successful track record. You believe in your system when you see, in your own experience, that it works over time, across market conditions.

So, keep working on your problems and am sure you will better off gradually!!

Good luck and hope it helps

Trading Q&A Audio/Video 1

Audio/Video response to the tweet posted on April 26th 2018

Here is the A/V link: