In this second part of a two-part episode of 2Traders Podcast, Darren and Walter talk about what discretion, intuition and large winning trades all have in common (this may be surprising). You will also learn about how the godfather of automated trading taught at a community college (!) and has since inspired traders like Richard Denis of the Turtle experiment and Ed Seykota of Market Wizards fame.
This trader (do you know who he is?) is considered by many as one of the most influential traders over the past hundred years.
Also, how to tell if the system works with Darren’s simple hack. The weirdest currency trader you’ll ever hear about down under (and how he spends time thinking about an aspect of trading most traders never consider). You’ll be laughed off the “free factory forums” if you adopt his trading technique. And what do winning traders do differently from the crowd (you must pay close attention to see this).
Did you also know that there’s an antidote for this common trading mistake? Find out what it is in this episode.
Finally, you’ll get why most trading systems don’t need to be fixed (and how fixing them can be dangerous – do this instead). All this, and more in this episode of the 2 Traders Podcast.
Download (Duration: 27:26 / 62.8 MB)
In this episode:
00:39 – how to infuse creativity?
02:20 – machine to beat humans
04:21 – machine learning
06:35 – a good tip
08:38 – seed your subconscious
10:43 – put systems in place
12:49 – perfect system
14:24 – cash register
16:36 – behavioral edges
18:34 – radical change
20:52 – chugging along
22:04 – adjust your rules
24:05 – single perfect strategy
26:05 – different fields
Walter: The thing about doing that when you’re conscious in your everyday going through life, it’s great. It’s great but it’s a lot better and it’s a lot more powerful if you can do this and put it in your subconscious with something like hypnosis or when you’re going in a hypnagogic state. So, that’s when you want to really focus in on it…
Announcer: Two Traders, Darren and Walter, pull back the curtain on profitable trading systems, consistent money management, and profitable psychological triggers. Welcome to the Two Traders Podcast.
Walter: Welcome back to Two Traders. In this Episode, you are going to hear about how you can infuse more creativity into your trading systems. The secrets to building profitable artificial intelligence based trading systems. How your subconscious mind directs your trading behavior and the best time of the day to seed your subconscious to profitable trading thoughts.
Also, you’ll get the two biases you must be aware of if you want to trade successfully for a long time. And really, how loose should your trading be. All these and more in this Episode of the Two Traders.
Darren: Good morning, Walter. Very good, thank you.
Walter: I think if you start with the end in mind like, what do I want to get? There are different ways to get that, right?
Darren: Yeah, definitely.
Walter: Adding things from other completely outside the box fields and things. I was listening to an interview with the guy who’s like a computer scientist and he programs, the big thing in trading is like AI and Machine Learning. Used to be Neural Networks. It’s moved on, it’s AI and Machine Learning.
Basically there are a couple of issues that have come up but he basically said, “The financial markets are swimming with all of these very intelligent people who’ve come over from other fields and have a computer background and they just think, we just have to let the computer figure out what the trading system is. What is going to make money and they find that it is much more difficult than they thought. It’s a lot easier in other areas.”
For example like building an AI machine to play chess and to beat a human. That is much easier because that is a closed system. You know what all the pieces can do, you know how big a board is and all that. In trading he was saying that what happens is, it changes because when you create a machine learning based strategy and then you start trading it, that changes the whole dynamic of the market.
He said, “one of the biggest issues was” — it’s fascinating — “one of the biggest issues with these systems when they’ve created it is, when you’ve put too much data in, what happens is you get basically like a middling system that will kinda do like, not kind of okay kind of plug along in all kinds of markets.” It’s like a Jack of all trades, Master of None sort of thing.
He said, “But really what you want to do is you want to look at a small chunk of data to create, let the machine create the system based on a really small set of data.” Which is completely different to the normal thinking. If you listen to people who are into automated trading, they are always talking about the importance of data. You need big large data sets.
What he said was, “No. you want a small data set and then you keep tweaking it and you keep adjusting the system by feeding it more new data as you go.” So you’re always kind of tweaking it rather than setting it a bit.
It makes sense because if you’ll think about the markets , we know that the markets go from constricted quiet markets that aren’t really going anywhere to trending markets to swing markets or very volatile but not going anywhere or very quiet trending market where it’s trending really hard and hardly retracing at all. There’s all these sorts of phases that the market goes through.
Like from abroad from a general sense and you can see where one’s strategy would work in one of those markets but totally fall apart in another one, it makes sense but I just find it fascinating how these people who are really good at Machine Learning and AI, when they’ve come to trading they don’t realize that it is completely different game because it is not a closed system, basically. The rules are always changing.
Darren: I imagine they come with this idea that the answer is to win consistently and all the time.
Walter: Yes, of course. They are always in the lower timeframe, quick profit. Exactly.
Darren: Which again, I suppose where our subconscious takes us. That’s the solution. This is about making money and people would want to make money everyday, every hour, every week. They don’t want to consider losing money.
Whereas, what you find in trading is the people who make the most money are comfortable with losing.
Walter: Yeah, no doubt.
Darren: That is really a hard idea to take on. Going back to the poker analogy, you’ll find the best poker players they’re not concerned with winning every hand. They are concerned with winning the best hands. The hands where they make big money.
It’s really a hard idea to take on and it is especially hard if you’ll just stay in this trading world because when you’ll go into forums, everybody is winning everyday. That is the story that you’re told.
Darren: Every now and then, you get one thread on there where a guy says, “Been trading for ten years, I’ve never made a penny. What am I doing wrong?” These are the threads where you’ll actually learn something. You learn about losing.
I think going back to this idea of seeding your subconscious, that’s what we should be looking for. We should be looking to seed our subconscious with the ideas that are not popular but still work. Go and look for those in other fields. There’s a lot of them out there, if you say that’s what your goal is, to find those.
Walter: Yeah and a good tip for people who are listening is to use that state when you are going to sleep. So the hypnagogic state is when you’re falling asleep. That’s when you can place things into your subconscious.
You hear a lot about positive thinking or mantras or stating all these things over and over again and all that. I even have a friend in highschool. I went over to his house and there’s all these you know those post-it notes, they’re all over the house and I’m like, “Woah! What is going on here?” Everywhere I look, I see these post-its with positive messages. I was like, “What the heck?” He’s like, “Oh! my dad wrote a book about positive thinking and he’s totally into them.” I said, “Oh, okay.” It was confronting to see all these messages.
The thing about doing that when your conscious in your everyday going through life, it’s great but it’s a lot better and it’s a lot more powerful if you can do this and put it in your subconscious with something like hypnosis or when you’re going in a hypnagogic state. So that’s when you want to really focusing on.
It could be as simple as, “I’m trying to workout the best exit strategy for my trading system and in the morning when I wake up, I will have an answer.” You can just kind of let it percolate and you could say, “Subconscious, tomorrow let me know what is the best solution is for this exit strategy.”
You could also put a positive message in there but you want to make sure it’s in an active voice. You don’t want to say, you don’t ever want to tell your subconscious, “I will start making money consistently.” That’s the last thing you want to do because it’s always going to be in the future for your literal subconscious. It’s sort of, “I am” as something happening right now.
So, that is another thing that you can do. You can solve a problem or a challenge or you can just seed your subconscious as you’re falling asleep. Just keep repeating it as you’re falling asleep. It’s a great time to do that.
So Darren, to me, you could still have a challenge as a trader, you still have these issues that keep cropping up in your trading but it’s sort of like the old Whack-a-Mole. Do you know the whack-a-mole game is?
Darren: I do, yes.
Walter: Yeah, they keep popping up. So it’s kind of like this where I think in trading especially if it is not clicking for you and you have these issues that keep creeping up. It’s like, you whack one and then another one pops up and it could even be the same one sort of disguised. So, what do we do there?
What do we do if we know it’s something subconsciously that’s happening? Do you have any ideas on that? What would you do? For example, let’s say a trader keeps moving his stops. So he doesn’t want to take the loss so he says, “Look, this is still a good trade. I’m just going to move my stop, give it a little bit more room and see how it’ll go.”
Of course the trade goes further against him. He said, “Ahh, I’ll just push that a little bit further because I know it’s going to turn around here. Here’s where the support is going to come in so I’ll be fine. I’ll just move my stop.”
And so what ends up happening is he takes in the mother of all losses. His big losers keep attacking his account and he knows this but he keeps doing it over and over again. How do you deal with something like that?
Darren: I think the hardest thing is actually knowing it and accepting it, that’s the hardest thing because generally they’ll cover it up with something else. They’ll make a story that didn’t involve them. I think if you know that you are making this mistake, I still think that and a lot of research backs this up, the best way to trade is to go systematic as much as possible.
Put systems in place for you to follow and then try and break those mistakes that you’re making. All of the research suggests that in a field like trading, systematic wins out. Now, that doesn’t mean intuition and using discretion has no value at all.
Generally, we’re better off staying in within a systematic approach. And so, imagine if you are a trader that has recognized that you’ve got a problem and whatever you do makes no difference then look at how you can become more systematic.
I see a lot of the time the decisions people are using to, the intuitive decisions they’re leaving without a strict rules set, they believe they’re performing better because of that. I think you really need to examine and find out whether that’s true. Wrap some strict rules around it and see if it still performs well.
Walter: Yeah, right.
Darren: I know it’s a [11:13 inaudible]debate this but I used to be using a lot of discretion in my trading. Purely because I believed it was the way to trade but when I tested the idea, I found that my beliefs are wrong or not.
Walter: It’s optimism bias and hindsight bias, right? We feel like, you look at the chart and say, “I wouldn’t have taken that one because of blah, blah, blah” you’ve concede it could’ve been a loser or whatever.
Darren: Yeah. I’ve got a good question from someone in my trading group, this week. So we trade a specific system and he has seen something and had an idea about kind of using some more discretion on the exit and I said, “Well, you know the system works well based on the backtesting and forward testing is going well. The system is making profit. Rather than this approach of trying to optimize one system to be the perfect system, take that idea and have a separate account and diversify. Run both strategy.”
Walter: Yeah, of course. You run a race basically. See what’s going to happen. I think we can trick ourselves into overestimating, how well things are going to work out.
Darren: We’re amazingly good at it. I mean, it can literally be, you could have traded the system for 6 months and then Monday, Tuesday you’ve spotted something that have happened and you want to change the whole system. That emotion is so powerful that it could make you do that.
It can make that small rate of data because it’s so current and particularly if you’ve taken a couple of losses on your system, you could see this tweak would have saved you those losses. It just completely squashes that data.
Walter: It’s so tempting though. When you have that creep up, it’s so tempting to modify everything and change it so that that won’t happen in the future. In life, that’s the way everything is run. You know like, “Well, my kid fell over here because he was wearing these shoes and he cut his lip. So he’s not going to wear these shoes anymore” or whatever.
Same thing with businesses, you’ll see the same thing. “Somebody stole money out of the cash register. So from now on, everyone is going to type in their code every time you’ll get into the cash register so we’ll know who’s in.” This is what happens in life.
The crazy thing is if you’ve fallen into the same trap as a trader, it’s a trap. Most of the time, it’s a trap. It’s not going to help you at all.
Darren: Is this “hot hand fallacy”?
Darren: I was doing really well at the moment. You jump on board with that and then you know, you see the EUR/JPY is moving so I’m going to jump over to EUR/JPY. Mike Bousson did a lot of research on this with fund managers.
They found that, the fund manager who did really well last year, everyone piles into that fund manager. And then, he doesn’t do so well this year, what they found is, it’s much better off to just stick with the fund managers that got average performance than jumping to the new star in the market.
Walter: I think you can also anticipate when the markets really going to trend because all of these articles come out especially in these Finance magazines and newspapers. They’ll come out and they’ll talk about how like, trend following is dead. It happens all the time.
You’ll see all these articles and they’ll bring up the famous trend followers that you follow like those Brothers in Florida, the Dunn. They’ll talk about how they’re just doing terrible and has been terrible for the last two and a half years or whatever. It’s so awkward.
You’ll see these articles come out and then boom! The next twelve months are amazing. It’s so funny how that happens. I know some traders that actually look at the cover of the Economist.
They used the cover of the Economist. Whatever is on the front cover of the Economist every week, they’ll watch it and they’ll see. A lot of times, the Economist is really good at calling market bottoms and tops because they’ll run the future story in the exact opposite. It’s crazy.
Darren: This is why I’m always saying you should look for behavioral edges and not information edges which are really hard to get. Or technical edges which are really hard to get because behavioral edges, they don’t change. They stay the same.
Walter: Yeah, it’s a lot less work isn’t it? Just try to figure out few behavioral edges than trying to keep ahead of the algos.
Darren: Definitely and if everyone is coming out saying that trend trading is dead, I’d be loading up before I was a trend trader.
Darren: Because the whole reason that trend trading works is that sometimes it doesn’t work. That’s the edge. Price does not trend all the time but then when it does, it trends really strongly for longer than you’d expect.
Walter: So true. The Computer Scientist guy who I was listening to the other day, he eventually came to the conclusion, it’s kind of along the lines of what you’ve just said, Darren. Because he’s saying, he was trying to figure out how the best go build these trading strategies using Machine Learning and finally he came to the conclusion that he should study fundamental analysis.
So he was throwing everything in the kitchen sink into building these algos and then he was like, he shifted gears. He started reading and learning everything he could about fundamental analysis.
Which is really almost about it as far as you can get from the algo world but that’s where he finally learned how to make his algos go. When he made that shift and kind of took a step back, look at the macro picture.
Darren: Definitely. I try to encourage people to do this all the time. If you’re stuck in this loop of doing the same thing over and essentially looking at the same thing and just tweaking the parameters, you’re not really going to make any radical change. It’s crazy to think that just by tweaking the parameters, all of the sudden you’ll just kind of hit this gold mine and it will completely change. You need bigger, more radical ideas.
Walter: That is right. So instead of changing from a 21 moving average to a 30 or something like that, what about scaling in positions? Or instead of taking, like you said, a 2R target and moving it to a 3R target, what about shifting it to a 12R target? What will happen there?
What would happen if you had a 6R target and a 12R target and split your positions out that way or use a trailing exit plus a big, fat 10R target? Here’s an interesting one. So I had a friend and he created an automated strategy. It’s basically based on this idea, during the interbank period.
So he would only trade during the interbank period which is fascinating to me. What that meant was, he was trading in the most eliquid time of the day essentially. The widest spreads, basically the period when nobody wants to trade because it’s so tough.
The market does not go anywhere. The spread is wide and that was his sweet spot, that is where he found his little edge. I think that, that’s the kind of thing we should probably look for.
If you’ll look at the numbers on the open position ratios — which I’m a big fan of watching — just to get a sense of the trend, what you’ll notice is that almost everyone is a reversal trader.
So all of these retail forex traders, they’re all basically selling uptrends and buying downtrends. They’re all trying to catch a falling knife. It’s ridiculous but it’s true. So what it does that tell you?
Like you’ve been saying, Darren. “Okay, how do I do something different to what they’re doing?” They’re all piling in, they all say, “Okay, this trend is going to be over. It’s been going for too long.” Well, that’s probably a sign that the trend is going to keep chugging along.
Darren: Yeah, definitely. I do this all the time. Think about what’s most popular with the people most likely to be losing money. Those are the things I don’t want to be doing. You can reverse that and say, “Find the people that we know are making money. What is popular amongst them and is there a complete mismatch there?” Do a crossover and things jump out [2048 inaudible] but you have to start thinking outside the box.
When I look at trading forums and the strategy pages, you can literally go from page after page after page and see no discussion on trade management at all. It’s a one-liner at the bottom of the twelve-page strategy and it’s not popular. So there’s a clue for a start.
Walter: Yeah, exactly. See how your equity curve changes if you are backtesting something. See how your equity curve changes as you adjust your rules in an area like, do you move to breakeven? Do you not move to breakeven? Do you have a looser trailing exit that lets the market jiggle around more or tighter one? Do you start off with a really lose stop or really tight one? All these things that Darren just hit to that, these are really, really fertile areas to look into.
Darren: Yeah. I see real radical change in the performance of simple systems by playing with the trade management. Real radical difference there but it’s very hard to take on board. You kind of have to work on yourself to sort of take that because it’s not natural to look into those areas.
Walter: Do you think that there is a different mindset between the average forex trader and the average share trader or stock trader?
Darren: Possibly but only because when, if you go on YouTube and you do a search on forex trading and do a search on investment in the stock market, the information, the seeds that are first planted tend to be different.
Walter: I agree. I think that the typical approach is fundamental approach for share investors and the typical approach for futures or forex traders is a technical approach.
Darren: Yeah and it tends to be much more long term in the investing world and more short term in the trading world. I’ve been studying investing quite a lot recently and I find that thing, that’s the one sort of gem I’m taking away from it. This idea of diversifying. It’s very hard in the forex world to see retail traders talk about diversifying. They tend to have this single perfect strategy idea. It’s very hard to find that in the investing world.
Walter: That’s right and a lot of technical traders will assume that if they’re trading different markets, they are diversifying, which is not. I think when I first started to get into trading, it was more kind of investing, sort of short term investing and the books I’ve read, they were all talking about how to pick good companies.
And then there was another book, that some of you might have read, the William J. O’Neil book How To Make Money Trading Stocks and that was kind of different because he had a little bit of an approach where you would look for certain fundamental factors but then you would also look at the chart.
So that’s kind of my introduction to chart reading and we used to get this big book called, Daily Graphs. It would come in on Friday. This was during the early to mid ‘90’s and you had this booming stock market in the States. The NASDAQ Market was taking off. You get this big telephone book size, these green books that would come on Friday and they were the daily graphs, the daily charts.
You go through there and see all these, it was like this filtering process of finding the right ones to buy. We didn’t hold them very long. Sometimes we’ll hold them for a couple of months or whatever but it wasn’t. There were a lot of genius traders back then. Kind of reminded me again of that one when Bitcoin has it’s big run up. There’s a lot of similar sort of things going on, there were a lot of geniuses out there.
Darren: Yeah, definitely.
Walter: Cool. Thanks for your time Darren. Is there anything you want to end with, sort of enclosing here?
Darren: Just really, perhaps consider some of the things we’ve talked about today and think about this idea of looking in different fields to how problems are dealt with there and applying that to trading. So if you’ve kind of been studying and working to be a successful trader for a couple of years and you perhaps hit a brick wall, stop looking at forex for a bit and have a look at some other fields.
Walter: Good advice. You can look into cognitive biases. You can look into Physics. You can look into different fields. There’s a book called Thinkertoys. It’s a really good book about trying to pull from other areas, other fields. Thinkertoys by Michael Michalko. I’ll put a link in the show notes. The idea is you just bring things from totally different fields and see how can we make this, how can we meld this to what we’re doing here, in the trading world or whatever you’re working on. It’s really a good way to mix it up a bit.
Thanks for your time, Darren. I really appreciate it.
Darren: Nice to chat with you again, Walter and I’ll see you next week.
Walter: See you next week!