Where do trading edges come from?

In this first half of a two-part episode of 2 Traders Podcast, Darren and Walter examine the efficient market hypothesis – why does the market move the way it does? The 2 traders also talk about arbitrage opportunities, cryptocurrencies, and making money by “picking up nickels.”

Walter talks about how a 14-year old is making money out of a new market and why this teen is different from the “traditional gamblers.”
Darren talks about the human side trading and why beliefs impact your view of the markets. You will also learn why simple entry is the best. All these and more in this episode of 2 Traders Podcast.

Download (Duration: 19:56 / 47.8 MB)

In this episode:

00:40 – inefficiencies in the market
02:00 – arbitrage opportunities
04:01 – markets being so complex
05:35 – Why is it hard to disprove edges?
07:41 – try and show or try and prove
09:16 – measuring edges
10:10 – eyes bleeding
12:03 – simpler big ideas
15:32 – dress up
17:48 – the inclination
19:07 – make more, lose more

Tweetables:
UThe higher the risk, the bigger the return [Click To Tweet].
Go with the simplest? [Click To Tweet].
Is it still profitable?[Click To Tweet].

Download The Full Episode 141 Transcript Here

Darren: Generally, if you want to make more then you’ve got to risk more…

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. It’s Walter here. Hello, Darren.

Darren: Hello, Walter.

Walter: We’re going to talk about edges, Darren. I know you’re really keen on edges and the lack thereof. Two related questions: Are there these inefficiencies in the market? You can read a whole lot of books that will tell you that the markets are very efficient. If there are inefficiencies in the market, where does an edge come from? Does it come from those inefficiencies or is it just something totally different? That’s really the question for this week. Do you wanna start off?

Darren: Yeah. The market inefficiencies is not really, I’ll be honest, it’s not something I’m an expert on. You know you could probably shed more light on that.

Walter: Well I guess, the basic idea with the efficient market hypothesis is really just that – and this is coming from a guy who has never done economic course so I really don’t know. But, my understanding is from the academics. Basically, the idea is that these markets are really taking into account all of the information that’s out there.

All of these market participants, they have information and based on that information they buy or sell. So basically, the markets are really where they should be. Right at any given moment everything’s been incorporated. All the information has been processed. All of the bets have been placed, so to speak. And so that’s why the price is where it is.

All of those arbitrage opportunities that come up when markets are really new. For example, in the cryptocurrencies. There’s like a 14-year old I know and he basically makes money by buying on one market and selling on another. It’s just that arbitrage opportunity that comes up a lot with new markets.

For example, right now as we are recording this, a lot of these cryptocurrency markets are fairly new. They’re decentralized. You can actually take advantage of that. There are a lot of traders that are doing that right now. Basically, picking up nickels.

I think this kid that does this, it takes him about 35 minutes to do one trade. But, as long as he wants to sit there and pound them out, he can basically buy over here and sell over there. Once it’s all done, he’s got a nice little profit there just for funding those inefficiencies.

The academics would say NO. There are no inefficiencies, the markets are very efficient. You might think that you know what you’re doing, that you have an edge, but you really don’t because everything that needs to be accounted for has been accounted for and so these markets are right where they should be.

Whereas traders tend to say things like — if you watch the economic channels or the finance channels people will say things like, “This share is undervalued” or “The dollar is overvalued” or whatever.

In their mind what they’re saying is that the price right now for the Dollar or Pound or for Google stock or whatever is really wrong. That there’s an inefficiency there, that their true price should be somewhere else. That’s what enables them to make money or that’s where they get their trading ideas from. I guess, that’s how I see it. I could be totally off here and I’m happy to hear from anyone else. So, let me know that I’m wrong but that’s kind of how I see it in my mind.

Darren: That sounds more reasonable to me, with markets being so complex and also people want price to move as well. They want the price to be wrong, don’t they? You have that human element in there as well.

When I look at it, I say there are certain areas that I don’t understand and there are certain areas that I don’t feel I want to understand. But I look at the information, you know from my point-of-view and say, “This is how I see it. Is it possible for me to generate an edge from that?” Really, I’m just saying, “Can I make an edge from my beliefs?”

Can I impose my beliefs on what I think the market is and how I think it operates? Is there a systematic way of planning out the market? Does it look in the past like that it had an edge? My beliefs could be just completely made up in my head but it’s still possible for that to have an edge.

Walter: Why?

Darren: Why? Because price moves. Price is always moving. So, if the price moves, there’s always an opportunity and the movement of price is so complex that it’s really hard to disprove edges, you know. It’s really hard to disprove edges.

Walter: What do you mean by that? It’s very hard to disprove edges. Why is it hard to disprove edges?

Darren: For someone to say that there’s an edge, they need to test it on some data. If you want to disprove that edge, you can only really say, “Well, it’s not going to work in the future.” And that would mean the future is measurable or you can predict what the future movements are going to be. That’s not true in my mind.

Walter: I think, you’re basically taking the Science… From my point of view, you’re taking like what Science does. Science never says “this is a theory of how things work. We’re going to do an experiment . This experiment will show and prove that this is how things work.”

What they do instead is they set up the strong hand hypothesis and they knock that down. They’ll say, “Well, since we knocked that hypothesis down, the most likely explanation is, our theory.” You know what I mean?

They just keep knocking down this strong band and the idea is that the last thing standing is their theory. That’s the whole scientific method in a nutshell, I guess. It sounds like that’s what you’re saying. You should really take sort of a scientific approach when you’re trying to determine whether you have an edge.

Darren: Yeah. Then, when you’ve decided on your edge. I suppose you can go and look for information to make that assumption more robust. For instance, you determine the edge was the trends exist in the market. Well, that’s fairly easy to test systematically based on past data. But you can also find a lot of successful traders that have traded using the trend as their edge. You could add that to it as well as more information to back it up.

If you want to go further, you don’t need to try and show or try and prove that, that edge really was as a result of the use of some sort of trend or their definition of a trend. Because, sometimes you might think that your edge relies on your ability to pick specific levels or timing. But it might be another element on how you’re trading that’s really making the edge.

I think you can test that by taking things away. I’ve done that before with very simple trading strategies with very few moving parts. And then taking, say you have a particular entry, you have a particular way of deciding what the trend is, then taking those elements away and comparing results.

I don’t know maybe that is curve-fitting in a way. But say for instance, I had a simple moving average crossover with a 5R target in a simple entry. And then I tested it, and it was profitable. What if I did the same thing but I took the moving average in this way and just flipped a coin.

Is it still profitable? Then you can start to say, “Well, maybe the moving average aren’t really that important at all. Maybe it’s the fact that I’m just letting my winners run and cut my losers short. That’s how I approach it. I’m not saying that this is the perfect way of doing it but in my mind that’s the only way of really kind of measuring edges. I mean, maybe that’s sufficient, maybe it’s not.

Walter: So, it’ll be like, if you had a system– I’ve heard of this system where if there are 3 bullish days in row, then on the 4th day you sell. But, you could change that and go, “Well, what if it’s just 2 bullish days in a row?” It’s kind of like the moving average example you were saying where you use the 6 and then you use the 8 and 10 and 12. If it’s just one setting that works, then you’re in trouble. Right? It shouldn’t be the case that ones like only the 5 moving average works.

Darren: Yeah, that’s what I’m saying. This is why I have endless arguments about entry patterns.  Because, I’ve done this until my eyes have been bleeding of taking the entry system and then making it more and more and more simple. What I find is that the edge doesn’t go away. You just play with the figures, basically.

The simplest entry system will generate the most entries, will tend to have the most drawdowns and the most consecutive losers. But at the same time it tends to make great profit because it generates more winners as well. You’re not waiting for so many stars to line up before you can take an entry.

Walter: Yeah. I’ve heard people talk about that. If you have two different systems and they’re pretty much equivalent, go with the one that trades more often. And that makes sense to me, like that idea.

Darren: Yeah. And then it just becomes a matter of making sure you set their correct position size and then executing it correctly. The one I test the most is just a single bullish bar breaking out for a long signal. That’s only really waiting for a very small bit of momentum in a direction. And you’ll find it has really big drawdowns and has a really long consecutive losers. But, it never misses a winner. It might miss one or two but it gets them all.

Then I tested it. Let’s say, 2 consecutive bars. You think you’re actually changing the system but you’re not. You’re just waiting for a bit more momentum. You’re going to miss a few more winners but you’re also going to avoid a few more losers.

So defining edges in systems like that is difficult to do. I think you have to go back to a much more broader view of it in and just simpler big ideas. For instance, a simple big idea could be once price gets moving in one direction it keeps going further than you think.

In other words, there’s an opportunity to get a few winners that are really big. So that’s a really simple defined edge that you could look to exploit. Likewise, you could say pretty much every entry point, will at some point go in your favor. So if I put really wide stop and I just get out when I’m in profit, I’ll be able to maintain a really high win rate. That’s another really broad simple edge to exploit.

I think that has to be the starting point. But it’s difficult because everywhere you look there’s really complex scientific ways of working out what an edge is. It’s really hard to trade a simple idea when you see that going on. You think, “Well, am I just too stupid. Is that the problem?”

Walter: I think that’s usually the problem with most things. No, I’m kidding. When you were talking about the system, like the 1 bar, the big bar breakout system and the 1 bar offers more trades than the 2 bar system but the 1 bar has more drawdown. How do you measure drawdown? It’s kind of a byproduct of your risk management. The way that you manage your position sizes and all that like your drawdown in terms of dollar value.

But if you look at it in terms of R, I think that’s actually a better way to do it. I’ve been looking at this lately, this idea of just looking at R drawdown. So if you were to run a bunch of Monte Carlo, you would get a distribution of R outputs over the next 200 trades or whatever. That would give you the range that you would expect to happen once you go live. Does that make sense?

Darren: Yeah. I always look in terms of R.  

Walter: Yeah. That’s the way to do it. For example, that 1 bar breakout system. The market prints a big candle. I guess if its a big bearish candle, you wait for the market to trade lower than the bearish candle and you go short. And if it’s a big bullish candle you just wait for the market to go above the high of the bullish candle and you go long. Is that right?

Darren: Yeah. It doesn’t need to be a big, big candle either.

Walter: Just a bullish.

Darren: Whatever you’re using to identify, the trends says short. If you get a bearish close bar then that’s a valid signal when you set-up a sell below the low and if it stops out and then you get another bearish bar then you sell again. Essentially, what you’re doing is it’s basically saying that the momentum’s down.

The long term momentum is down. But you’re looking for the best value, sell into that. It’s basically a value entry into, if you think in terms of investing, you’re picking a stock that’s going up. This is a good value point to buy. That’s essentially what you’re saying.

Even simple things you can dress up as sounding like a really intelligent, well thought out trading strategy. Lets say, I want to see more confirmation that price is continuing to go down. So I’m going to wait for a lower low, lower high to form and then I’m going to enter. What you’re doing basically is waiting until it’s not quite as good value. You’re just waiting for a bit more momentum. But essentially the strategy is exactly the same.

Obviously, you’re not going to generate as many signals because the momentum is not always going to be dropping when the long term trend is down. Sometimes it’s going to be sideways and that more complex entry is just not going to happen but the very simple one is. That very simple entry is going to get in at the best value all the time. You have more potential of hitting a high risk reward.

Walter: But what if someone says, “Yeah. That’s right, Darren. But I don’t want to deal with the drawdowns that I get by trading every bar, every candle that goes in the direction that I expect.” For example, I’ve seen systems that are really good, have really good risk reward, really solid hit rate but they just don’t happen that often.

The argument is either one, this system you don’t have a lot of data and this system is just really on the lucky streak over the last 5 years. You really don’t have enough data points to know the true win rate of the strategy. You think it’s going well. And it is going well simply because you’ve only got 30 data points or whatever for example. That would be one point of view.

The other point-of-view is this really works, you know it doesn’t trade that often but when it does, I want to take advantage of it. So the temptation is to really lay it on thick in terms of risk. When you get one of those signals. What do you say to that? Obviously you and I both know the inclination is to want to win. When you first start trading you want to win.

And I’ve heard this over and over again, people who don’t know anything about trading will say “Well, so long as you win more often than you lose, you’ll be alright.” That’s kind of where we are coming from when we get into this game. Then later on you kind of realize not so much. So what do say to that. To the guy who says, “Hey look Darren, I got this strategy trades on the weekly chart. I don’t get a lot of trades but tell you what, it’s 5 to 1, it’s got an 85% hit rate.” Why don’t I just trade that?

Darren: Because in my experience…

Walter: It’s going to revert to the mean.

Darren: If you really want a low drawdown, you don’t want to lose a lot.  Then that’s going to be reflected in your possible returns as well. Because if you want to make really big returns, when I’m talking big, let’s say 50% a year. You’ve got to get comfortable with losing a lot to do that. Based on the evidence that I’ve seen.

I find it really hard to find better or more experienced traders than me to disagree with that but that doesn’t mean it’s not possible. But generally if you want to make more, then you’ve got to risk more.

Walter: Alright, that’s it for Part One. In Part Two, you are going to hear about magicians in the markets. What this means for you and your trading. Also, how to know if your strategy is going to make money over the long term and what the Shakespeare monkey means for your trading. Whatever that is. You will also hear the Turtle bummer and how to test for your luck in your trading strategy.

Also, how to know if you actually have an edge or not and finally the story of the nervous Las Vegas gambler. What this means for your trading. All these and more, in the next episode, Part Two of the Two Traders Podcast.

Why do most traders lose in forex?

In this part two of the two-part series, Walter and Darren talk about the problem with high win rate trading and why you need to look out for this. You will also learn how you can use losing as your advantage and why it actually works. And what do the expert poker players do differently?

These are the pros and you’ll see why this is an advantage and this can help you in your trading as well.

Finally, did you know there’s a weird way to see forex volume on the charts? All these and more in this Episode of Two Traders.

Download (Duration: 18:04 / 43.4 MB)

In this episode:

00:50 – how children can help
02:48 – how to see the volume
04:05 – a bit of an illusion
06:39 – simple core ideas
08:20 – biscuit test
10:18 – the losing trader
12:16 – the assumption
14:33 – own image
16:10 – a sentiment

Tweetables:
Use your logical side [Click To Tweet].
What do you believe in? [Click To Tweet].
Trade what you see[Click To Tweet].

Download The Full Episode 140 Transcript Here

Darren: I don’t think you’ll learn from one losing trader. You learn from a lot of losing traders and yourself if you’re not making money and try to find the connection with what you have in common. That’s the good place to start…

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. This is Episode 140 of the Two Traders and in this Episode. This is Part Two of the two-part series, you’re going to see the problem with high win rate trading and why you need to look out for this.

Also, why most traders lose in forex and how you can use this to your advantage as a trader. How children can help you find the best trade setups and why this works. What expert poker players do differently? These are the pros and you’ll see why this is an advantage and this can help you in your trading as well.

And finally, the weird way to see forex volume on the charts. All these and more in this Episode of Two Traders.

Darren: Do you think there’s any validity in this idea that you can watch individual candles and work out the sentiment and use that rather than having a strict pattern-based way of approaching the market? You can read the wicks and the movement, and essentially just use that as your trading strategy. So you know when to get in and you can read when the market’s going to reverse and then you get out. Do you think there’s any validity in that or do you think that’s a good way to trade for some people?

Walter: Yeah. I’m sure there’s something there but to me that’s almost like the guys who study the order flow or the way that the volume might ticker. I don’t know if that’s what you mean. But to me, that’s the same realm. Like apparently, Jesse Livermore did that and there are some people, I think a lot of them are future’s traders or index traders.

They might even just look at tick charts where the candle is based on a certain number of ticks. 1400 ticks or whatever, something like that. That’s kind of what they’re doing, I think. They’re watching the flow and seeing if they think the momentum dies out or whatever.

I’ll never forget there’s a trader called Emmanuel. He’s in the UK and he’s in the forum too. I remember I was talking to him one time, this was years and years and years ago. And then he said “I saw all this volume coming in…” I said, “What do you mean you see all this volume coming? How do you see the volume on the chart?” And he was talking about the chart.

You know, it printed a really big candle. He was using that as a proxy for volume. I thought that was interesting that, that’s how he viewed it. He viewed these big candles as volume candles. Right? That was a lot of push behind that. I suppose it makes sense but it never really.

Darren: For me, it would be like a poker player who made his bets on reading the other poker players who sat playing with him. And the amount of money in the pot made no difference to him. For me, I’d look at my cards, I see my hand. I see what the flop is. I look at the other players and from that I’m going to work out whether I’m the best player who sat on this table or not.

However, much I’ve got to put in or however much I’m going to win in return, is I’m not going to consider those things because I’m most likely to win the hand. You know, that’s how I see it. And I don’t see long-term successful poker players that play like that.

Walter: Yeah. I wonder why. Is that just a losing strategy?

Darren: Yeah, I think so. I think it’s a bit of an illusion.

Walter: I think sometimes you can trick yourself into seeing patterns. For example, let’s say, you’re long on a market and you’re in this long position and you know, the candle closes. It’s a nice big strong bullish candle so you’re in profit. And then sometimes you can think, “Okay.”

When you watch the next candle print, if it starts going higher, right as the new candle starts and it starts looking really strong, a lot of times you might say, “Ah okay, that’s not a good side, that’s probably going to end up by the time this candle finally closes. It’s probably look completely different and it’s probably going to go against me a bit. Be a bit of a bearish candle.”

And likewise the opposite, “If I’m long and the market’s behind me, I’ve got some profit booked.” You know in theory, if the next candle starts to go a little bit bearish at the beginning, I might feel okay about that. But it’s more likely than not going to close bullish in my favor, in other words.

Sometimes we see those things and it may seem like that’s always the case but it may not be. I know you would say that in general about almost everything. I think, sometimes, we can kind of trick ourselves into seeing these things and kind of relying on them but that’s where the data comes in.

You’ve got to use that logical side of your brain to say that, “Well, typically if the market is in an uptrend, the next candle starts off. If the first 10% of the candle goes against that trend. Then that candle will generally close.” That’s a testable hypothesis. That’s something you can definitely go and look at just like moving your targets further out or whatever sort of thing.

All those things can be tested. Once you test them, that’ll helps you to believe in it and convince yourself that you should stick with it when times get tough.

Darren: I don’t remember who said it but it was one scientist who said that, good ideas essentially, you should be able to explain it to a child and the child should be able to understand it. If that’s true, if the child gets it, then you’ve probably got a pretty solid rule set.

I try and kind of force my trading into that and just kind of strip away everything down into some really simple core ideas. Then I’ll accept that everything else that’s going on in my head is just psychology and bias and they’re trying to complicate it. But if I stick to those core ideas, in the long run, that should be fairly robust. I think it was Fairmont, was it Fairmont? (The quote was John Taylor “It is true intelligence for a man to take a subject that is mysterious and great in itself and to unfold and simplify it so that a child can understand it.”)

Walter: I don’t know.

Darren: I can’t remember, a Mathematician or a Physicist or something. But I like that idea and I’ve seen you do that on your webinars before. Where you look at a chart and you say, “I’ve got a few friends on Facebook who were mad into, they’re never traders before, then mad into bitcoin.”

So initially, they were into bitcoin and now they have been into that for about a year. Now, they’re into technical analysis and bitcoin. And they post these youtube videos of bitcoin analysis, and these videos are like 2 hours long with millions of studies going on. And you know, I say to myself, “Look it’s going down. Look for sells.”

It’s going down at the moment, it’s clearly obvious. You can talk all day about where it might bounce, whether this is an indication that the bounce is starting or not. But if you just simplify it and say, “Well, at the moment it’s a shot.” And then look for cells in that condition. You don’t really need to go any further than that. I don’t believe you need to go any further than that. I could be wrong but I think that, that’s a good approach to the technical side of things.

Walter: Yeah. That’s where I came up with my biscuit test. There was a trader, he was on a forum or something. All these traders were like, “How do you determine the trend?” He said, “Well, I only go long when it’s a bullish trend or it’s bearish, sells. When it’s a bearish trend and so forth.” And everyone will say, “Well how do you know?” “Well, I have this proprietary trend indicator.”

At that point I’ve seen enough to know. You know what? A lot of these things you can use. There are 75 ways to calculate a moving average but you know what? They’re all going to tell you pretty much the same thing and it’s the same in this trend indicators.

I’m really lucky because I’m at the point now, where my kid’s old enough that he can tell looking at a line whether it’s an upline or a downline. That’s all you really need, isn’t it? You just need to have someone who doesn’t have all the crap in their head that you have in your head. And just say, “Look, is that line going mostly up or mostly down or is it just up and down. Up and down?” That’s all you really need. I really believe that it’s all you really need.

There are people that pay for proprietary moving averages. Just imagine that. It just seems beyond bizarre. Why would you pay? Really, you would pay for the Jurik moving average or the Demark moving average this and that? People pay a subscription to get these moving averages. How can it really be different from any other moving averages? It’s all what you believe in, I guess.

Darren: I think, if you’re still asking what the period of the moving average they use in this, then you’re still in the wrong mindset. That’s my opinion.

Walter: Yeah. That’s a good test. Alright, the next question we have here for our session here is the losing trader. What do you learn about trading from losing traders, if anything?

Darren: What you should look for is what did they have in common, I think. I don’t think you  learn from one losing trader. You learn from looking at a lot of losing traders and yourself, if you’re not making money. And try to find the connection with what you have in common then that’s a good place to start.

Walter: So things like focusing on the wrong areas like digging for gold in the wrong spots perhaps. Perhaps having the mathematics of your strategy all out of whack or whatever like the expectancy or whatever it is.

A lot of times, as a beginner trader you focus on the wrong things like win rate. You really want to win. You need to ask yourself, “Why is it that I really want to win? Why is it that I want to have such a high win rate?” Because that’s really going to help me here. If my goal is to profit, why is it going to help me to be the type of trader who wants to just win? Is that really or are these goals in conflict?

So you can look at groups of traders. You can see what they’re doing consistently, which is typically taking quick profits and taking huge losses and trying to win often. Those are the big ones, I think. And then also focusing on the wrong thing.

These traders who look at, trying to filter out losing trades or trying to optimize which leads to curve fitting. All of these typical errors that we all make in the beginning by focusing on the wrong things and getting it backwards. In terms of trying to filter out bad trades, trying to win all the time. It’s all about winning.

If you just pick somebody out on the street and you say, “How does a trader make money?” A lot of times, what  you’re going to hear is something along the lines of, “Well, you just have to have more winners than losers.” Like, that’s the assumption, isn’t it? So I think, you can definitely look at the groups. See what the groups of losing traders are doing and see what they’re focusing on.

Darren: I think one of the difficulties is it’s quite hard to find losing traders as well.

Walter: Really? I think it’s easy.

Darren: Well, where do you find the losing trader telling you what he’s doing because whenever I go on forums and read people’s trade journals, they’re all winners.

Walter: Well, all I do is I just look at the aggregate of the retail traders. That’s what I like. The reason why is we know that most of them are losing.

Darren: Yeah. I think if you just Google for retail traders, statistics, winning, losing, there are some really good stuff in the internet. I posted something a years ago. I think, it’s from Dailyfx.

They’ve got all the data from all the brokers and they showed you what the average win rate was and what the average winner was, and loser. You know that sort of data was basically compressed everything down into a simple idea. Most retail  traders have a win rate of 50% or above but, their losers were much bigger than their winners. That really compresses everything you need to know from losing traders into sort of one simple idea.

Walter: Exactly and they tend to fade the trend. So if you see them all grouped up, all bunched up going long a particular market. Like 78% of the traders are long the EUR/USD then go and switch on the chart and what you’ll notice is that the EUR/USD will be in a downtrend.

It’s like magic how often that happens. What they’ll do is they take their profits on the little retracement moves during a trend. They’re all thinking that they’re going to catch the end of the trend but at the end what they’ll end up doing is — it’s just like giving a personality to a cat. I’m just creating my own image of what’s going on — but they tend to, if you watch the stats, they tend to take profit on these little retracement moves.

So, the EUR/USD maybe falling 1200 pips but it may retrace a 110 pips and that’s where these losing traders are taking their little profits. Trying to find that reversal point. So it’s really useful because it will fluctuate. So if you watch the numbers, it will fluctuate. You will see it if they’re all grouped up in one side then it’s a trend in the other direction.

When the numbers change and they start to get out of that fading trend position, that usually means that it’s sort of the end of that retracement move. It’s like having your finger on the pulse of where they’re getting and also you can see these. You can see where the orders are too.

Some brokers will let you see that. Like Saxo Bank in Oanda. I’ll put the links in the show notes for everyone. So you go in there, especially if it’s made a new high and a new low, it’s really obvious. If the market’s been kind of choppy and up and down then it’s a little bit tricky. But basically, what you see are where their stops are.

You see where all the losing traders’ stops are. Say, “Okay, if the market spikes there, then a lot of people are going to get cleaned out of this.” So it’s really kind of interesting. You can definitely concoct a strategy out of just these data. Like, where are the orders and what proportion of the traders are long or short, for sure.

Darren: Yeah. It’s like a different chart basically.

Walter: Yeah. It’s like a sentiment. It’s like a different chart. Exactly. We can learn a bit from losing traders. What about this topic of trading what you see or trading what you think? I would have to say, just guessing from hearing about your style that you would just say, yeah. I just basically trade what I see and try not to let the thinking get in the way. Is that fair?

Darren: Very much so. Yeah. For me, it all has to be planned out in advance. It has to be as close as systematic as possible. For me, I’m just looking to see the correct setups and the correct exits and then just executing. I don’t trust what I think at all.

Walter: It’s tricky, isn’t i? I think, it’s helpful to keep your thinking inside the box of your rules. So if your rules are, that I only take a trade when the market retraces and does this particular thing then you do that.

People will ask me these questions, something along the lines of, “Hey Walter, do you ever just look at the market and just base on whatever price action is doing, just take a trade?” I’ve heard that. What’s interesting about that is that, I did. But when I did that, I was losing money. It’s like, you feel like I should know what the markets going to do. Therefore, I just go ahead and look at it, figure out where it’s going and then do it.

Alright, that’s a wrap. Thanks so much for spending time here and we’ll see you at the next Episode of the Two Traders Podcast. Happy Trading!

SHOWNOTES:

Saxo Bank in Oanda

Will watching the like a hawk charts improve your trading?

In this first half of this two-part episode of the 2 Traders Podcast, Walter and Darren dig into trading techniques, biases, and the psychology behind the expectations for your trading systems. Darren talks about the emotions that creep up when you spend time chart-watching. He also examines this common trader bias and how it impacts your confidence and ultimately, your trading results. You will also get this trick that improves your trading precision… Do you know what it is?

According to Walter, your trading performance boils down to these two things. He also shares an easy hack for exposing your own trading biases. Walter shares a story about a fund manager and how he discovered the market’s “big days” which you will also learn about here. All this and more in this episode of 2Traders Podcast.

Download (Duration: 18:06 / 43.4 MB)

In this episode:

00:40 – unfold in real time
02:09 – executing a decent plan
04:02 – the math side
06:03 – why it’s not working?
08:05 – redesigning plan on the fly
10:04 – easy way out
12:33 – the forgotten trade
14:40 – after the crash
16:02 – what Walter typically do

Tweetables:
Emotions will trip you [Click To Tweet].
The real challenge is execution out [Click To Tweet].
It all comes down to your system[Click To Tweet].

Download The Full Episode 139 Transcript Here

Walter: And I find that I often make really, really poor decisions when I’m watching…

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 to Two Traders Podcast. It’s Walter here. Hello, Darren.

Darren: Hello, Walter.

Walter: Today, we are thinking about this idea of if you watch the charts, will it improve your trading? Another way of looking at this is will you learn how to trade by watching the candles unfold in real time? Is that time well-spent? What say you to that? What do you think?

Darren: It’s really difficult to tell people that a certain style of trading is not going to help them or is going to help them; or is the right way or wrong way. But, I think what we can learn from — you know, we’ve kind of done like a mass social experiment by the explosion in retail trading.

There’s been like a big experiment going on and from that we’ve discovered that people have got certain weaknesses as traders. Certain things are going to trip you up and make it difficult to trade.

What I see really often is that they’ll tell me their trading plan and it will all be planned out and back-tested and they’ll have an expectation for their trading plan. What you find is that in live trading, their plan performs better than them.

They might have traded for 3 months and broken even or lost money but their trading plan for the last 3 months made really good returns. You see these a lot and I think pretty much everyone suffers this to a certain extent.

What you can learn from that is although it’s fairly difficult to develop a decent trading plan, the really difficult thing is executing it. If that’s the case, then sitting there staring at the charts when you don’t necessarily have to is not a great way to approach it.

Now, someone might turn around and say, “Look, I can tell by the shape and the pattern of the candles what the overriding sentiment is.” And that may be true but when you’re doing that, you’re looking at just a small part of the information. If you’ll look at all of the information, what we find is that people make failings when they try to execute their plan. They do that because of human behavior and biases and emotions.

When you’re staring at the charts, you’re generating emotional reactions because you can’t just sit there and think what’s going on. Those thoughts are driven by emotions. Being excited, being bored, being anxious, they’re all driven by emotions. Although you could trade by watching the charts unfold, you’re basically tempting yourself to make human errors so I’d say it’s a bad idea.

Walter: Right. I agree with what you’ve said. Like, I’ve always kind of said that trading for profit is pretty simple in terms of what the moving parts are. You don’t really need that many levers and it’s not that complex. Although it becomes kind of a look-at-me sort of thing when you have these groups that have tons of money to burn through and create algorithms and things like that.

I mean that to me is an unnecessary fluff but that aside, I think that it basically comes down to two things. Your trading comes down to your system which is the math side of it. We’re talking about statistics, probabilities, odds, all that stuff. And the other side of it is really, “Are you executing?”

Those two things: whether you are executing your strategy and whether your strategy will make money. That’s basically what it comes down to. It’s not that difficult. To that end, what I would say is yeah, I think you can get a lot out of looking at the charts.

I don’t think that if you’re in a trade you just necessarily watch it that often – at least for me and the people that I have come across. One of the things that happens there is you typically can talk yourself into a different idea after you have taken the trade.

You take the trade. You’ve got an idea. You’re going to stick with this and then you watch it and then you start thinking, “What about this?” You know you can talk yourself out of it.

I don’t think that’s necessarily good. But I do think that, in short, looking at the charts concoct a plan and an idea of how you want to interact with the market whether it’s a pattern, whether it’s the fact that you notice that the particular pair gets relatively volatile at a certain time of the day.

Whatever it is, there’s something that you see that you think makes sense to you. You can build a strategy based on that. You can build a strategy that has an edge. But, like you say that’s not all of it.

I think the longer you’re in this game, the longer you do this, the more years you’d spend doing this, the more obvious the psychology becomes. It’s one of those things where yes, you have all these profitable trading strategies that are out there that anyone can literally go into the search engine and pick up off the internet for free. Right now, you can go and do it.

It’s probably going to be difficult for most people to make that work because they don’t believe in it for whatever reason. They haven’t convinced themselves that it would work. And more importantly, when they start trading it, when you start trading the system, you find all kinds of reasons to change it or explain why it’s not working in this particular instance or whatever.

In other words, it’s the execution part of it that really gets in the way for a lot of traders. I definitely agree with that. I would just say that I think, my belief is that I think you can look at some charts and come up — and we’re talking about this from a technical point of view, obviously. People who take a fundamental approach. A pure fundamental approach may even state that you don’t need to even look at the chart. You would never even need to see a chart to trade or whatever. Although, maybe those guys are investors on that trader but some of them would be for sure.

I would say yeah, you can get a lot out of the charts. I don’t think it’s necessarily very productive while you’re in a trade. Although, if you’re trading like really quick little in and out trades, I suppose it’s quite useful. Even then, maybe not. Maybe just lock it in and let it ride. But I think that the real work comes in on the execution side so definitely, I agree with you there.

Darren: Yeah. I think when you look at charts in real time as well, whether you like it or not, your mind is kind of making a narrative about what’s going on. I think with experience that tends to sort of die down. But certainly, initially your mind is sort of generating this narrative, almost like you knew it was going to happen.

Walter: Hindsight bias.

Darren: This hindsight bias. Like, “I knew it was going to reverse there” but that’s after it’s reversed. So you build this confidence in your ability to read what’s going on with the market. I think that’s a bit of an illusion and it’s one really easy to buy into. Especially if you’ve got a trading plan that in the short term is losing.

Say, you’ve started the week and you have taken 3 losses and then you’re watching the charts. You kind of, in your mind start redesigning your trading plan on the fly. It’s a really dangerous state to get in.

That’s why I always say that, the exercise you should be doing when you’re looking at charts is, “How accurately can I replicate the plan that I built up over a long time?” So your trading plan that you’ve done a lot of backtesting on and you’ve got all the data. You know exactly how to enter and how to manage your trades.

What you really should be focusing on is not how the candles are evolving. It is, what is the next stage of the plan that I need to execute and how can I do that as precisely as possible. Because that’s the only position you really should be aiming for.

It’s the precision of your actions and how you execute. Then, if 3 months down the line, you’ve executed your plan perfectly and your results are very bad. Then, you consider making changes. But you need to get to that point where you’ve executed with as much precision as you can.

Walter: Yeah, and the questions will come up. Like, “If my plan tells me X, why do I keep doing B?” That’s the confronting thing about this. You learn that, “My plan says that I’ve got to get 4R out of my trades and I keep averaging 3.1R. Why am I doing this? What’s going on here?” That’s really where the work comes in, doesn’t it?

Darren: Yeah. But I think, once you’ve accepted that, once you’ve realized that, that’s the problem, then we have a kind of, repetition of trying to execute better. You find that you do get better at it and those psychological issues tend to sort them out then. But you need to accept it in your mind first that, that is the problem. I think that’s a hard step to make because what you tend to do is to just change your strategy, rather than your behavior.

Walter: Yeah, that’s the easy way out. That’s definitely the easy way out. And that hindsight bias thing you’re talking about, I distinctly remember having these systems. That I would read about in library books or kind of tweaked something that I’ve or something like that. And I would look at it on the chart and then I would have all the indicators there and everything. I’d say, “Wow this is amazing! It works so well. Look at what it would have done here, and there, there and there.”

It was only when I started to scroll back. This was before I even knew about Forex Tester. But it was only when I started to scroll back and look. I would actually pull a spreadsheet out or like a notepad, I would literally, bar by bar scroll the charts forward and create this track record of basically backtesting it. It was only then, when I started doing that, that I  realized how much hindsight bias was affecting me.

I mean, it’s a really good thing to use a simulator or something like this so you can experience what it’s like to actually trade the system. Otherwise, that hindsight bias would color what you see on the charts. You will negate the losers and make up reasons why you wouldn’t have taken that trade and it’s just crazy.

Darren: I have seen people who do watch each bar unfold. Make their decision. Take their trades, and manage their stops and make it work. At the same time they tend to be following a well tried and tested plan. Although, it looks like they’re acting on the fly, there’s still a strong plan behind that.

So, I think you can do it if you have a strong plan behind it. But there’s a lot of studies as well that suggest that it doesn’t improve. It’s not good for decision making. You’d be in a much better frame of mind to make good decisions if you did step away from the charts and do different stuff. Distract yourself from it, if you like.

Walter: One of my friends, his best trade, he had it years and years went. He took the trade and forgot about it. And then he came back after the summer and realized he still has the trade on. It was his best winner ever. He decided not to trade in July and August or whatever it was. He came back in September and he said, “Holy crap. I forgot about that trade.”

Darren: If you look at the SMP500 every decade, it’s kind of doubled or something. You say, “It’s simple. You just buy and you hold it for a long time.” But then, when you actually look at the changes in prices there then, in 1 decade you were like in drawdown for 8 years. And then in the last 2 years you went into profit. In another, you had massive profits and it re-traced all the way back down to breakeven before finishing. You see what I mean? A simple plan on paper is great but if you don’t make the journey and execute it, that’s difficult to bear. To live through those drawdowns, etcetera.

Walter: Yeah. I think there was a study done. There was a fund manager that did the study. He was like a smaller fund and he said that the larger funds, made this statement, “It’s really good to just remain in the market. Just write it out and stay in the market.” This is like the accepted wisdom point. Everyone should just write it out, stay in the market. We’ve all heard that.

Basically their point was, if you don’t stay in the market — all of these funds would say in their materials — if you don’t stay in the market then you’ll miss out on the big days. There’s like a handful of days, the days that really move where the majority of the year’s move is made only just a few days. What was interesting about what he said was that he looked back, and those days, do you know when they occur? These days where the markets moves really strong and goes up a whole bunch. Do you know when they tend to occur?

Darren: Was it the day before the worst day? Or the day after the worst day?

Walter: Yeah. The day after the worst day, that’s exactly right. I thought that was so funny because the funds did not tell their investors this. They have to stay in the market the day after the crash because those are the days when it rebounds so much. They know this, but they are not telling you this. So his whole point was he was trying to figure out a way to stay out of the market when it gets really volatile and when it’s likely to crash.

Basically, that was his whole point. But I just thought it was funny because it’s like what my Statistics Professor used to say everyday when she walked to the class. Every day she’d start the class the same way. “There are lies. There are damn lies and there are statistics” and it’s so true. You can make it look good no matter what sort of hypothesis you’re trying to support, you can make it look good. Like this funds do. Anyway, I thought that was quite interesting.

Darren: Do you have like a system in your trading where you regulate how you look at the charts? Or you sort of naturally fall into it like a routine with that? Or do you just essentially check it when you feel like it?

Walter: The chart? Do you mean if it’s an open trade or looking for a trade?

Darren: Just in general, if you’re trading.

Walter: Yeah. What I do, I typically will look at them. Where I live, the D1 candle for the New York 5 P.M. charts, that daily candle starts in the morning for me. So what I typically will do is after that candle prints — in the winter it prints quite early and in the summer it prints a little bit later. What I’ll do is I’ll wait until that prints and then I’ll scroll through my charts and I’ll just have a look. I’ll just go through all of the charts.

I have a few that I have on a watch list and I’m kind of waiting for a possible trade. But I’ll just scroll through them and then, that’s when I record my video and post it in the private forum basically. Then I’ll say, “Look, this is what I’m looking at. This is what I like.” That sort of thing.

Then what I like to do is later on in the evening, here in Australia which is in the European day time, that’s when I like to put my orders in. So that’s all I really do. And I don’t typically watch them. There’s really no reason to. The only thing I might do is see when I could possibly move the risk. So, the risk is off and it goes to breakeven. That’s about it, really. That’s what I do.

I find that I often make really, really poor decisions when I’m watching.  I don’t like doing that. What I mean by watching is, if I’m in a daily chart trade and I check it like every 4 hours or every 3 hours, something like that. That’s what I’m talking about. It’s counterproductive for me, anyway.

Okay, that’s it for Episode 139 of Two Traders. This is Part One of Two and in the next Episode in Part Two, you’ll see the problem with high win rate trading. Why you need to pay attention to this.

Why most traders lose in forex and how you can use this to your advantage. You’ll also see how children can help you find the very best trading setups and why this actually works.

What expert poker players, these are the pros, what they do differently and why is this an advantage for you. This will help you in your trading too and finally, you’ll get the weird way to see forex volume in the charts.

All these and more in the next Episode of the Two Traders. We’ll see you there.

Why are traders obsessed about the wrong thing?

In this Part Two of a two-part 2 Traders episode, Darren and Walter reveal some tricks about compounding. What does “big market data” suggest about the behavior of the markets – and should you heed these data? You will also learn about this crazy magic fix for all trading systems that will keep you on the right track.

Walter talks about the psychology behind the “normal curve” obsession and offers an “insider hack” for you to use for your trading. You’ll also get the “genius” of the low IQ trader and how he pulled consistent profits with his approach.

Darren also shares a simple but great edge to exploit in your trading. According to him, this one of the easiest ways to make profits from the markets. He also talks about learning to focus on the right thing – should you dwell more on the outcome or the process itself? All this and more in this episode of 2 Traders Podcast…

Download (Duration: 24:04 / 57.8 MB)

In this episode:

00:38 – one magic fix
01:29 – why is the trend your friend
04:12 – what’s interesting about the statistics?
06:14 – all go broke
08:55 – the low IQ guy
10:34 – not at the optimum
12:27 – riding a bike
14:22 – poor execution can hurt
16:26 – it’s a trap!
18:38 – swayed by emotions
20:11 – a bad habit to get into
22:41 – out to the extreme

Tweetables:
Is the trend your friend? [Click To Tweet].
The hardest part is getting out [Click To Tweet].
Get enough information to build[Click To Tweet].

Download The Full Episode 138 Transcript Here

Walter: I remember seeing with a trader and he was like, “I’m gonna get out of this trade. I can pay for my new kitchen. It’s exactly what you were saying.   

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: In Part Two, you’re going to hear about what big market data tells us about the markets. Why we traders are obsessed about the wrong thing. The one magic fix for all trading system. I know it sounds a little bit crazy but it’s true. You do this one thing and you’re generally going to be alright with your trading.

Why traders are obsessed with the normal curve and here’s a hint, it actually shows up anywhere even where it shouldn’t be. And also, you’re going to get the genius of the low IQ trader. What he did and what you can learn about his approach.

All these and more in this Episode of the Two Traders.

Alright, are you ready for the next question? Here’s another one we’ve got: Why the trend is your friend? It seems to me the market always moves much further, much faster when the trade is over. What can you say to that?

Darren: The first part, why is the trend your friend. For me, it’s because you can make a mathematical edge out of the fact that trend exist. What I mean by that is that if you have a system that uses some way of indicating the trend and let’s say, you have a 3:1 target.

So you have a fixed target of 3:1 generally if you double your target to 6:1, then the decline in your win rate tends not to be half and that’s when you’ve got a mathematical edge by using the trend.

If you can test the system on different targets and you find that you are seeing a similar decrease in your win rate when you increase your target then that is one way that the trend can be your friend.

In most of my systems, that holds true. It’s not completely linear but you’ll find that exactly the same entry criteria rules. If I double the target, I tend to make more profit than you’d expect from that.            

Walter: Have you thought about why that would be the case? I have some ideas. In theory, people will say, “You take a trade 50-50 chance” in theory, you would say, “If I double my target from 3R to 6R, I should also half my win rate but it doesn’t happen that way”.

Darren: Obviously, I have not done my own research on this. I’m using other people’s research but generally when you look at price distribution, it has fat tails. They’re fatter than you thought they’d be.

So in other words when price gets moving in one direction, it tends to continue on in that direction longer than you’d expect. That seems to have been the rule for markets from day dot. I am using other people’s research on this but there’s a lot of research, there’s a lot of data to say that’s true. Though I cannot say they are a 100% true. I’d say that based on evidence the probabilities are pretty high that’s true.    

Walter: I’ve got the same theory that William Eckhardt talks about in the New Market Wizard Book. I tested one currency pair, the Swiss Franc and I found exactly what you’ve said that you could break down anything.

This is the interesting thing about statistics is that you can sample anything. If you do a random sample, you take a random sample what should happen is, any distribution should line up with the normal curve which is kind of a weird thing but that’s the central limit theorem. So, you should take anything unless you get that.

What that means is, you should know exactly where everything should fall according to the standard deviation. That wasn’t the case with this Swiss Franc. I looked at it and it was like almost 300x more volatile on the tail. On the fat end where there should be only a few data points. There were like almost 300% more. So to me, that’s like I’m happy enough walking around with my confirmation bias if that’s the case because I clearly haven’t tested any other currency pairs.

It makes sense. I mean, you look around and you see these volatile periods that shouldn’t happen that often but they do. They happen all the time so to me, that makes sense. Clearly, if you’re using a trailing exit or you’re using a system that takes advantage of that and there’s a real edge there, isn’t it?

Darren: I think, it’s the strongest and the easiest edge to exploit. When you listen to the guys that have been around for 20 years, you’d find few of them disagreeing with that and that’s a good thing to base your trading on. You can do your own testing. Your own testing of just a year or 2 or 3 years, it should show that edge.

Walter: What’s interesting to me is that the traders who do the opposite. They have used the normal curve to set themselves up. So, they’re depending on everything falling within the normal curve and if it does then they’re going to make money. They don’t want those tails to pop up and if they do, very rarely do they want it to. Those guys have all gone broke.

It’s amazing to me. If you’ll look at those traders in the market that do that they all go broke. You can look at all of them and all of them have. Some of them, multiple times. It’s crazy to me. I mean, when I say, all of them, I’m talking about the famous ones.

Obviously, there were traders we’ve never heard of who’s using that idea which is basically an idea that, basic idea is, the market can only go so far before it’ll come back. They typically go broke when the market go so far. They expect it to come back and it keeps on going farther and farther and then they go broke. Meanwhile the guys who are taking advantage of that with the trailing exit or whatever, they are making money.       

Darren: I think one of the problems with trend is we can be obsessed about forecasting them and finding the exact start and picking trends rather than a system of getting big gains when they do occur. We get obsessed a little bit too much about that.

If you look at great trend traders, they’ll often have losing years and you’ll say, “Well, if his success was based on these facts that he can predict the trends, how can he have a losing year?” Because he should in theory been able to say, “The signal was not right and so I’m not going to take a trade” but, they don’t do that.

They like taking small little bites then when the big trend comes, they have a systematic way of getting the most out of their strengths and they pay for their small losses. You find that pretty much uniformly across the board. That’s how they approach it which gives you a clue that obsessing about the right moving average crossover or combination of indicators to perfectly pick the right trends of the start of the trend is not really the way to go but it is the way that we are attracted to that approach. Most would use very simple ways of identifying the trend.               

Walter: I was just going to say that. A lot of them where you can  just say, “If price goes up, we buy. It goes up, we buy. If price goes down, we sell”. My friend who got me into trading, he said, “You need to go take this course on how to trade currencies” so I went and took the course.

He took the same course and in his course he said, “You know who the best trader was?” When he did the course, it’s like a week-long course and he said, “The best trader was this guy who was clearly not the sharpest tool in the toolshed.” You know what he did? That’s all he did. He just bought when it went up, bought when it went up and sold when it went down. He did really well. Whereas, everyone else was overthinking it. I just thought that was fascinating        

Darren: Do you mind of entry systems I played around with? Eventually, you’ll come to that conclusion. Buy when price is rising and sell when  price is falling.

Walter: The hard part is getting out of that, deciding when are you done. Having a mechanical trailing exit is really your friend in that case.  

Darren: I think so and also the mindset that there’s no optimal because the optimal exit last year could possibly be really terrible this year. It’s like when I run tests from 2R to 10R and then repeated it with various, different trailing exits. What I realized is that when my wins are much bigger than my losers then I’m generally going to be okay.

So what I need  to do is I need to select one that’s kind of a risk profile I’m happy with. I could live with that drawdown. I could live with those returns. I can work out how much I need to risk and I know that this is not always going to be the best but over the long run, I’ll stand a good chance of making a really good returns.

You need to get comfortable with that idea that you’re not at the optimum, not the optimal exit. You’re always going to find trades that turn around just before they hit your target or you hit your target and then they continue they go. That’s just the nature of the game and you need to get comfortable with that.                    

Walter: That brings us to the next question. I think you’ve kind of tackled it which is: Isn’t it better to take quick profits than to wait for more profits as it can go against you and you can lose what you had? In other words, you can’t go broke taking a profit. What do you think about that quote? They say, “You can’t go broke taking a profit.”       

Darren: Well just the nature of the question suggests that the answer to that is not known because if you’re asking that question then do the testing. So, if in your mind with your entry setup and how you trade, taking profits of 1:1 risk/reward is more profitable but go and test it.

Do exactly the same trades with te 2R and a 3R and a 4R and then with a trailing stop and see if it’s better. If you find that it is better, then you found an edge to your system that it’s better taking profits quickly but do the testing first and use all of the information.

Generally, when we ask question like that which is kind of going on in a gut-feel. Probably you’ve had some losses where they weren’t profit and the emotion of those losses, it’s weighing your opinion and you’re discounting of a data there.                

Walter: I think part of it is that’s just what we do in everyday life. We learn something, think about like trying to ride a bike, you learn something. If I do this, I’ll fall off the bike so maybe I’ll do that.

I think in trading, we carry that with us where it’s, “Okay, hang on. The last time I did that, this is what happened so maybe I’ll do this. Do something different this time.” that’s our natural tendency but it works against you when it comes to trading.         

Darren: Yeah and the difficult thing is, it’s completely possible to make profit from exiting trades early but history has shown us that the people that make the most money generally don’t trade that way. It’s a question of how much information you’ve got that you’re basing your trading on and how good that information is.            

Walter: Absolutely.

Darren: I do know some people that trade that revert inverse risk/reward and they’re kind of playing with the same edge there really. They’re playing the edge of keeping their win rate high rather than the edge of having winners much bigger than losers. Both edge can be exploited.

It’s very hard to say that one is better than the other but all you can do is you can look at your trading approach and how you want to trade. Get information on both of those approaches and see which one appears to be better based on data.                 

Walter: To me, the two big strikes that, that quick-profit-high-win-rates system has and I used to try and do this is that you may pay more commissions in theory and then if you’re not really on top of your game, if you’re not really executing well, like just a little bit of a poor approach in your execution can really hurt you.

So I feel like, for me anyway I’m better off and you know, I’ve always kind of toying around the idea of really going for it one time. Just really testing it out and see if I can do that again. When I mean again I mean, I used to trade D1 charts where I basically go for like 1.2R or something like that. I don’t really do that anymore.

I’m just wondering the way that you see things, do you see it the same way because I just see those commissions as really taking a bigger buy out of my profits if I do that. And, I feel like I really need to be on top of it because it’ll get a little sloppy that can really hurt as well.                 

Darren: I’ve never traded that style really but I think so, yeah. Things like getting gapped or slippage can make a huge difference if you’re doing that inverse risk/reward thing because you tend to have to trade a much bigger size. Like you say, if you’ve got very big account, it’s harder to manage that sort of strategy.

Psychologically, it’s a different sort of pressure you get from that because you can’t go like a whole, you can go instead of like having a long drawdown period that you might have with the high risk/reward system. You tend to have long periods of just grinding and going nowhere, just basically trading a breakeven, you can have periods like that as well. It’s not my way to trade but you can make an edge out of it.

I think the danger is that it’s appealing and that always turns me off solutions to trading properly because it just seems you see, you’re really comfortable to just keeps locking those winning days.            

Walter: It’s a trap.

Darren: Yeah and I think whenever it feels kind of, “This is really easy”, that’s when the red lights are going off for me. With everybody losing money or large percentage of traders are losing money then, it’s not going to come easy, it’s not going to feel comfortable. It’s going to feel difficult and hard work inside and that kept me safe the last few years.        

Walter: I just imagined the mouse crawling, “Oh, look at that cheese. Wow! It’s just sitting there. I’ll just go in there” then slam! It was too easy, mouse. You’ve made a big mistake. Definitely.

If you’ll look at all of the trading systems out there my guess is that most of them would be related to sort of the quick-profit 1:1 or even less than 1:1 risk/reward. Seems like that is the sexy thing. I could be wrong but that’s my guess. Most of what’s out there is what people wanted, I suppose. I agree.      

Darren: Most of the systems I read, they seem quite good until they get to the crunch part which is how to manage the trade once you’re in it and when are you going to take profit. I see such a huge percentage that don’t even talk about that.

They just talked about the setups and analysis in the entry. It’s like their edge is clocking winners and they’re not even considering how big those winners are going to be. All they’re concerned about is how frequent they’re going to be and it’s kind of like, taking half of a trading strategy away, maybe even more.

So, if that is your approach to trading, I think you’re going to come stuck at some point because without a clear plan, you’re going to be swayed by emotions, by what happened in the last trade, by what sort of data you’re having, by what’s the weather is like outside. All those things are going to be pushing or pulling your results around because you haven’t predefined where is the most important part of your trading strategy.       

Walter: Absolutely. I remember seeing with a trader and he was like, “Oh, I’m going to get out of this trade. I can pay for my new kitchen. It’s exactly what you were saying. He just completely switched off the strategy, the trading strategy and just said, “Hang on,” he just realized, he was just looking at the trades and he’s like “I’ve got enough in this trade to pay for a new kitchen that my wife has drawn up. I’m out of this trade”. It’s so true. It’s so  easy to switch out of execution mode and look at the what is available in terms of profit or loss.

Darren: I can go on weeks without looking of what my trading account balance is now. I don’t look at it. I’m not interested. I need to get up and I’m looking at the correct entry. When it comes, I’m setting my target and how I’ll run my trailing stop and then I’m on the next trade.

I’m not focusing on how much money I’ve made in the outcome because I think that is a bad habit to get into. It’s focusing on outcomes rather than in process. You generally know how well you are doing.   

Walter: One last question. The other issue I have with the inverse reward to risk or high-win rate strategies like that are that, if you were to throw a dart and let the dart decide whether or not you would take a trade or what currency pair or buy or sell or whatever, if you were to throw a dart with your 5:1 reward to risk ratio strategy, you’re probably going to make money and you can test this on your own and see.

But if you were to throw a dart with the 1:1, I don’t think you would. Although, I have to admit, I haven’t tested it. So, I’m just wondering what are your thoughts on that? It just seems like, that piece of data, if that’s true — now, I’m interested — if that’s true, doesn’t that tell you there’s a fatter edge, so to speak in the low win rate, high reward to risk ratio strategy?          

Darren: Yeah and that’s what most of the studies into that have shown. So basically with the inverse, you’re basically saying that your ability to forecast and predict the market is going to remain consistent. Again, that is a dangerous mindset to get into, I think. It’s a flimsy edge to hang your hat to that thing.         

Walter: To depend on, exactly.

Darren: Yes, to depend on.

Walter: There’s another guy that I’d read about who, he had like this automated strategy. He would keep taking trades and it had like a 1 pip stop so he kept getting stopped out, and then occasionally he will just hook into one. If you’ll think about it, if you’re up like 100 pips, you’re up a 100R. It was just crazy.

He would just keep taking these trades and then occasionally, — I guess quite rarely — he’d hook into a winning trade. It seems like to me, it would be really, really difficult to trade a strategy like that but it’s kind of like the extreme of what we’re talking about.   

Darren: Yeah, definitely. He’s taking it to the extreme and it’s really good to do that with a strategy you trade. It really take the targets out to the extreme and look at the data you get back from that.

Take all the stages in between and you get a good math and you can clearly see them when you’ve got that amount of data in front of you where the edge lies. And then, it’s just the case of making personal decision, where on this lie, am I going to feel comfortable. How far can I push this and feel comfortable.

That is my approach to trading and it’s certainly not for everyone but it is a simple edge to exploit. It’s technically simple to exploit. You really need to just get enough information and build up some sort of trust in a systematic way of exploiting that. I think as human beings, it’s one of the easiest ways to make profit trading markets.                

Walter: Well, thanks for your time, Darren. I really appreciate it and looking forward to the next episode.

Darren: Okay, Walter. Thanks, see you next week.

Walter: See you.