Why do people get into trading?

In this episode of 2Traders Podcast, Darren and Walter dig into the hindsight bias and why you need to be wary of it with your trading. You will also learn about Bayesian Probability, statistics, and a lessons on optimism – might it help or hinder your trading? And what’s the difference between hoping and cheering?

Walter shares a story about risk. And he shares his test results of William Eckhart’s trading concept. Darren shares an interesting idea by Nassim Taleb and how it gives you a better chance of understanding probabilities in your trading.

Download (Duration: 37:12 / 89.3 MB)

In this episode:

00:38 – sunny but cold
02:14 – slightly destructive mindset
04:36 – salary job
05:33 – trading time for money
07:52 – realistic expectations
09:20 – overestimating our abilities
12:04 – overriding system
14:07 – trading like a machine
16:04 – write a rule
18:35 – “screw-you-money”
20:22 – complementary system
22:22 – reasonable expectations
24:14 – fallback options
26:05 – fly to the moon
28:09 – open mind to possibilities
30:52 – variants in the outcome
32:27 – manage good and bad luck
34:46 – writing down vs. typing

Tweetables:
We overestimate our abilities [Click To Tweet].
Why not automate? [Click To Tweet].
Follow your rules[Click To Tweet].

Download The Full Episode 137 Transcript Here

Darren: In the last ten years, I’m always overriding my system. I know it’s my biggest failing but it has never been more profitable than it would’ve been just to follow my system.    

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 the Two Traders. It’s Walter here and I’ve got Darren. Hello, Darren!

Darren: Hello, Walter.

Walter: How are you today?

Darren: I’m good. It’s sunny but cold which is what the English summertime is like.

Walter: It’s like just enough to tease you.

Darren: Yeah. You look out of the window and you think it’s a lovely day but there’s like an icy cold wind.   

Walter: That kind of reminds me like the food you might get in an amusement park. It looks really good. Looks just enough to buy it and then you taste it. That’s funny. Maybe too many Disneyland pretzels for me.

We had some ideas here, Darren. This first question that we’re going to tackle, we’ve got a few that we’re going to tackle for this episode. One is this idea and it’s come through actually from a trader.

She said that, “Why is it taking so long for me to start making money trading?” Actually, 2 traders asked essentially the same question. “I’m making x percentage but it’s just not enough.” I think part of the deal here is that the feeling from this trader when she wrote in and then another trader when asked me this question was, “You know, I feel like it’s great and all that I’m making money but it’s not just happening fast enough.”

I think the real question is when can I quit my job? How do I get to the point where this trading stuff is taking over and is providing enough for me? So that is the first question. What are your initial thoughts on that?     

Darren: Firstly, it’s kind of a slightly destructive mindset to focus on the money early on in trading even if you’re being successful and profitable. I don’t think that it is particularly a good mind set to take forward because you are starting to focus on the outcome rather than the process.

Sometimes, I mean it depends on your strategy and what your actual figures are but one of the strongest edges when you’ve got a profitable trading strategy is to use compounding and that is slow to take effect.

You might think, “Well, I’m making 3% a month” based on your current account, it’s not enough money but with compounding, if you could do that for 2 or 3 years, you can make a really good income from that. That’s one thing, it’s to consider compounding.              

Walter: Absolutely. If you’re pulling profits out then obviously, you’ve got to be patient with it. That might mean, starting off with a smaller account or whatever it is. But you’re right, I totally agree there.   

Darren: Really what you should be looking at is, “Am I making a return each month for each quarter? — or however yours is measured — and is that sustainable? Am I going to be able to do that consistently or is it just that we’re in a particularly favorable market condition at the moment?” If there is a good evidence that you can be consistent then with compounding overtime, you can make any returns you like.  

Walter: Exactly right. It’s like the money catches up to your account sort of thing with that curve.  

Darren: Yeah and it takes time to get to learn patience with something like this because we do come at it to the wrong mindset. We come at it like this is going to be an income source that is nothing like anything I’ve done before.

Whereas in fact, if you are a consistent trader it is very similar to a sort of a salary job. You need to look at what you’ve got, coming in each month. You’ve got to look at what you’ve got going out and you’ve got to spend that excess income wisely. In trading, spending the money wisely things like saving or compounding.

We really tend to have a very opposite mindset like this is a lottery ticket and boom! You’re going to make an incredible returns every month. I think we can be quite realistic about it but that force sits at the back of you mind. That’s what draws a lot of people to trading.      

Walter: Do you think part of it is like the idea that you’re kind of changing the rules of the game? Most people will essentially in their work, they’re kind of trading time for money. Even if you are a commissioned sales person, you generally will see your income increase the more time you put into it.

So like around Sydney, you see these guys in the real estate business. They are on their phones all day and they are showing homes on Saturdays, all these sort of thing. They put a lot of time into it and in theory, they are really only making money when they are making their sale. They could, in theory, rip off 3 sales in a week and make a big pile of money. And so the salary per hour is pretty high but in the end, it typically is that the person that puts a lot of time in is the one that’s making the money.

I’m just wondering if on the phone and all that sort of thing or whatever they’re doing, they always seemed to be on the phone in Sydney. I don’t know if it’s part of the deal but it seemed like it is.

One of the attractions to trading for a lot of people is that, “Hey, I can get paid for not really sitting around, punching a clock like what I’d do somewhere else.” And so, there’s this idea that you’d go make money while I sleep sort of thing. Is that something that you think is unrealistic or we see it in one way as we’re getting into trading and then later on we kind of see differently?                            

Darren: Yeah, possibly. It comes back to this idea of expectations. We seem to write our own expectations and basically ignore all of the facts. If we looked at all of the facts about — let’s say, you’re a retail trader. If you look at all of the data on retail traders, the fact that you are making any money at all, you should feel pretty happy. If you’re looking at all of the data but we don’t have that within us.

We think, “I’m definitely at the top 3% data.” Maybe the top 1% that’s what we think naturally. “I’m skilled. I’m going to be in the top of retail traders. I’m going to be making the big bucks.” Which is kind  of like not looking at all of the facts, isn’t in? All the facts are that a lot of people who started trading, they never make money at all. We need to be a bit realistic in our expectations.

Walter: There was a guy in the forum who was saying, “Hey, my account was begging me not to trade.” Because he had seen so many accounts and so his account was like, “Don’t do it. Don’t do it.” It was just interesting.

I thought that he was like, “Hey guys, what’s going on here? My account was just saying don’t do it. Is it really that bad?” Sort of the question he floated out there because you’re right, the numbers are stacked up against you.

It’s the same thing with acting that you have these people moving to Los Angeles every year. All these people from all around the world every year, they’re just pulling up from wherever they’re from. Indiana, Poland or Australia wherever they’re coming from and they’re going to make it big in Los Angeles. They all end up waiting on tables and waiting for their big breaks sort of thing.

I guess in a way, trading is very similar. You have all these people who’ve got the New Trend Masters 6000 system and they’re going to take it for a spin with their broker. I think we have this optimistic view of overestimating our abilities and also seeing it like, “Look, this is what trading is. Trading is an exciting thing where you get in and you make money.” The reality, to me anyways is nothing like that.

To me, so much of it is getting your hands dirty with data and questioning your perceptions. For me, a lot of it is, “Why did I do that?”  “Why did I make that decision?” Or “Why am I thinking this now?” Or I think I have this idea that is going to make for a good trade setup, for a good system and then when I run it through its paces, it is a total crap. Why is that?

A lot of what I do is questioning not only my perceptions because a lot of times like if I look at certain things, it’s obvious that would work if I used that as a strategy. But then when I’d go and test it in Forex Tester, it comes out total crap. I just can’t make it work. Most of those things in fact, end up like that and so I’m always kind of wondering.

It’s also trade management too. If you give yourself any sort of discretion with your strategy, you’re always going to question whether or not you made the right decision. Unless of course if you’re still on the fence and make the half decision, that way you’re always right, right?

Darren: Yeah and the same goes for systematic approach. With the systematic approach, you’re always looking back and saying, “You know what? It didn’t feel right, that trade and if I could’ve just got rid of that rule and use my discretion then I’ll avoid all of those errors,” which again is an erroneous thinking. It is just not true.

Walter: It’s so true. This week, I had a trade where I was feeling really good about myself about getting 3R out of the trade and pulling up then I thought, “I’m sure we’re getting really close to the end here. I better get out of this” — and my minimum target was 3R.

I was feeling really good about getting out there and I’ve decided to leave a very, very tiny position on and just see what happens and then of course, it just took off. In some ways, that was the hardest. It’s easier to take a loss in some ways than to have that situation where you take a profit and then you’ll look back and you’ll go, “Wow, I really should’ve waited.” Those are tough to deal with, I find.        

Darren: I don’t think in 10 years of trading that I’ve ever performed better than my system. What I’m saying there is that in my last 10 years, I’m always overriding my system. I know it’s my biggest failing but it has never been more profitable than it would’ve been than just to follow my system.   

Walter: When you say that, so what you’re saying basically is that you often overwrite essentially the rules that would’ve been executed had the system been automated. Is that right?

Darren: Yes.

Walter: So why not automate it? Because a lot of people are going to ask why not just automate that. What’s the concern? Letting go?

Darren: Yes, letting go. It’s fear. It’s ego. It’s emotion. It’s bad decision making, that’s what it comes down to. If we could put all electric cars on the road and they were safer than humans but they cause random derves, we’d still think that humans are better drivers. We’d still think that electric cars were a bad idea. It’s how we’re setup.

The only problem with automated systems is that humans overwrite them. They do it too often and they do it usually because of emotions and bad decision making but, you can find a happy medium.  

Walter: How?

Darren: You can decide to be systematic in your trading but trade it manually and know that you’re going to have a desire to override but you kind of use that, that’s your trade. Your trade is, can I be a good trader by being systematic? Can I follow the rules? That’s our trade.

It is against yourself really more than the market. The system is dealing with the market, that’s what the system is there. That’s built on a large massive data then your skill as a trader is executed in that. You’ve got a nice half-work there because you’re trading like a machine.   

Walter: But you take the credit for it.

Darren: Yeah. You are allowing yourself to feel that you are in an important part of the process, maybe that is what we need as humans. Now, I can see that really smart people just automate because they realized it.     

Walter: That’s true. When I think of the automated trader, the two people I think of are in the  forum: Adam and Mark. I used to say to Mark, I said, “Mark, everyone is a discretionary trader because even the automated traders turn the system on and off.” And he finally said like after a few years, he finally said, “Okay, I get it. I agree.” He finally said, “I agree.” Not that that was like a great win or anything. That was just my belief that we’re always able to flip the switch at any time and kill the system even if it’s fully automated.

The other interesting thing is Adam, who literally programmed these things for a Market Wizard — literally was the programmer, creating these systems — he’s complete focus is on the discretionary trading. So I find that fascinating that the two people I know best as sort of automated traders are both kind of, they’ve got at least one foot on the discretionary side of things.  

Darren: Yeah and really when you think about the discretionary decisions you’re making, now they have to be in your mind. The decisions you’re making on what the market is telling you.

In your mind, your mind is making up rules about what it’s looking for the market to tell you so you can trade. So you should be able to write a rule about that and if you can’t then you don’t really understand what the market is telling you.  

Walter: Because you don’t have a system.

Darren: Yeah, you don’t have a system. You are saying, “Well, it just look like it was going to trend.” Well, what elements of it looking like it was going to be a trend was there and why can’t you define them?

If you can’t define them then you’re basically saying that you just had an emotion and you acted on that emotion. We know that, that’s not a good way for humans to make rational decisions. It’s like there’s a book of books in it out there. It’s very hard to find evidence that that’s a good way to make good decisions.       

Walter: I totally agree and I’ll never forget the one time we had a bunch of traders on a webinar. I said, “Let’s look at the M1 Euro” and I said, “I want to get a consensus here. When everyone agrees that this chart is going in one direction and that we’re ready to take a trade, let’s do it.”

And so the little M1 candles were ticking up, up, up and everyone is okay, the uptrend is on. Damn it if that thing didn’t turn around right there. It was just too obvious. It was amazing.        

Darren: So, going back to the original question.

Walter: Yeah, so we talked about compounding. We’re getting impatient. We’re focusing in on results here and feeling like one really really freeing thing to do if your goal s to get out of your job, is to have enough money sitting. Just try to be frugal for awhile and save some money up so that you do not have that pressure to trade.

For example, let’s say, I’ve got a job and I want to quit my job. Well what if I can just make a 3-year plan. I know, it sound “3 year, really that was so long”. What if I can just have these goals that every 3 months, every 6 months, every year, I want to get my trading account to a certain level. See if I can do that.

Just see if am I maintaining monthly and quarterly making money. I’m compounding that and at the same time, saving in a way. What you want to do is to have enough money so that when you quit your job, even if you’re trading totally goes in the can, you have that screw-you-money where you could just say, “Screw you. I’ve got money. I can live for nine  months” or whatever, you know what I mean?

It’s really empowering to have that and to be able to say, “I’ve got screw-you-money. I don’t have to take a trade. I don’t have to make money this month” or whatever. That sort of thing where you don’t actually have to pull money out of your trading account. I think that takes the mental weight off of it.

The other thing that you could do is prove it to yourself as a trader that your trading account makes more than your salary for x number of months. Again it might take some time to build it up, compound it and get to that point and then you’ll go, “Well, this account is now pulling in every quarter, every month, every year” whatever it is, you’ll go, “This is pulling in more than actually I am making in my job”.

So, that’s another way to do it. People think, ”That’s so crazy. That’s so far away.” Not really. If you run the numbers and I’ll put the spreadsheet in the show notes for everybody. You can download that and have a look. You will be amazed on how the compounding works. It’s like a magic thing.

You just have to give it enough time like Darren said and then you will see it. The curve, it’s like this very steep curve, the farther on you go down in time, it’s one of those — I don’t know what it’s called — like parabolic or whatever, it’s really sharp. It’s not a 45 degree angle line. It’s parabolic and so it gets really, really sharp at the end there. What you basically need are enough trades so that’s the other thing.

Let’s say that Darren trades his system and it’s making 5 or 6% a month, is there any way that you can add a complementary system? Or the second, probably my least favorite thing would be to add more markets.

It’s better I think, to add more systems than markets because once you start adding more markets, you can get into trouble with correlated results and that could be really tricky. Psychologically to deal with a drawdown in both accounts. That is another thing to keep in mind.

The shortcut for compounding is more trades. It’s not taking more risks. Taking more risks will send you to a steeper valley and once you get down to that valley, people freak out and that is where they make the big mistakes.

So I think, building up a little nest egg of money, trying to setting up yourself goals but again like Darren said, it’s really really important to look at this way. You have a profitable trading system, you know that the system is profitable. The only thing that is going to break it is if it just stops working. What would happen if you just focus on the execution of that strategy? Not with an untoward results. What would happen like logically  what is going to happen?

If you focus on just executing that strategy over the next 2,000 trades ,what is going to happen? The most likely thing that is going to happen is that the system is going to make money. If you don’t take the money out of the account, and you keep risking the same percentage, the fixed fractional method then you are going to build that account. It will compound. It will get bigger and bigger, that’s what will happen.

The only thing that could happen is one, you don’t execute the strategy as you should or two, the system totally falls apart. That’s really it. I mean, the most likely thing that’s going to happen is it’s just going to keep chugging along.

Darren: And I think, work on expectation. I talked about it a lot. Write down what your expectations are and see if they are reasonable. If you must focus on the outcome and how much money you’re going to be then base that on reasonable expectations.

Study and read stuff from people who’ve been around for 20 or 30 years and made a lot of money. Consider how and what their journey has been like. Did they all make it on their first year? Have they grinded their way and done the same thing for 10 or 20 years and that’s where they’ve amassed their shoots well.

Perhaps we spent a little bit too much time on public forums and kind of get caught up in the hyper of those little bit too much. I’d say, stop looking at them. Find people who’ve been trading for 10 or 20 years and made a lot of money.

A lot of them are out there sharing their story and you’ll find that they were grinders. They had setbacks. They had years when they didn’t make money but they’ve had a long term view and that’s where their real profits have come from.      

Walter: It’s amazing how the people who stick with it end up doing alright. It’s the people that quit, that fall by their ways, it’s almost as if you do it long enough, you’ll eventually figure it out. I really believe that.

It takes some people longer than others — I’ll raise my hand there — and forward a bit years that I was just but I was like, there was no doubt in my mind. I mean, think about that, 4 years I was thinking and in the 4th year, I was still thinking, “This is going to work. This is going to work”.

It was discouraging but if you’ll talk to some of the older traders, you’ll hear the same stories. They just knew that, that is what they’re going to do. They didn’t have any fallback options. They were totally going to do it.   

It’s amazing to me when you have that approach, how easier it is to keep the faith. Keep your eye on the goal. Keep your focus. It is discouraging. It stinks sometimes but it’s also liberating when you just know it’s going to happen. Like, you know you’re going to make it work.

Some people, they’re trading forex this year. Next year they’re flipping real estate. Another year, they’re riding the bitcoin wave or whatever. They’re always kind of doing something different and that’s cool.

I get it. They are looking for opportunities but the people that are in trading, who like you say, have been trading for a long time, we’ve all been through tough times. It’s just that we’ve kind of stuck with it and I really do believe that if you stick with it, you will work it out. It’s going to happen. It’s going to work.          

Darren: Yeah, definitely. I read this week that trading is very similar to dieting and there is no correct diet. It’s the one that you’ll stick to that is the diet for you. Again, it’s human nature not to want it.

I think also nowadays, it’s much harder to stick — I don’t know if it’s harder to stick — to long term plans now than it used to be but certainly most of our cultures set up around instant gratification. We want everything instantly.

Computers get faster, they still seem slow. Computer today, you think of the computer, they used to fly to the moon. NASA used to fly it to the moon. I think now you can get it in a watch but computers still seem slow today because the return effect diminishes to you.

So, that long term view is really hard for human beings to get onboard with but the important part of that is, you are trying to be in the top 5%. So you’ve got to ask yourself, “What is it about what I am doing is going to make me different to a 95%? Where am I going to find my edge?”

It’s in things like that, being able to stick in things for a long term. Being able to hold on to trades longer. You’ve got to think, “What are the most common failings for traders? That is where I’m going to find my edge because I’m going to put systems in place so I’m not making those mistakes”.                        

Walter: Absolutely. I definitely agree with that. We have another question here for you, Darren. Ready for number two? So, the question is: If I’ll lose on the trade, did I do something wrong?

The prompt for this is I read a trading book once where one of the trader said and I find this really fascinating because I never really thought of it this way but he said, “If I take a trade and I lose on that trade, I believe the market was trying to teach me a lesson.”

I have to say, I definitely didn’t agree with that. I definitely do not agree with that. So, I’m wondering what are your thoughts are on that?      

Darren: Well, you could’ve made a mistake but…

Walter: It’s possible but his point was every losing trade that he has, — assuming of course perfect execution, the reason why he lost — we’ll take out the execution part of it which I know is he big part but he’s basically saying the market is teaching me a lesson that I’m supposed to learn but if I go back, I should have done something and if I hadn’t done that thing, that would have been a loser.

To me I thought, “Wow,” I’ve never even consider it. It kind of opened my mind to possibility but still I don’t believe it.

Darren: Yeah, it’s almost like they have a belief that if they’ve got the right skills then they’re never going to lose.

Walter: Yeah, they’re kind of saying that, isn’t it? In kind of the reverse way.

Darren: Yeah, it’s like what they hate the most is, you just don’t know how to read the market. This idea that if you had the skill then you would’ve taken that lost which a lot of people hold onto but I don’t find many traders who’ve been around for a very long time that have anything like that sort of belief. In fact, it tends to be the opposite really.

Whereas, they’re kind of more surprised when they’ve got a winner than when they’ve got a loser. They’re almost expecting it to be a loser. When it works out, it is right. That’s nice, luck was on my side that time.    

Walter: Absolutely. I know that thought. When you’re trading for big wins, definitely you’ve got to get comfortable on that area. Like I was, I’ve ever thinking this week. I’ve only had this one trade but I took it and I thought, “Man, that stop loss is so tight. I’m definitely going to be popped out. I’m going to wake in up in the morning and find that I’m popped out” and it didn’t. I said, “Wow”.

It was like, you were saying expectations before about setting expectations and I’m reminded of, Denmark usually comes out as one of the happiest country if not as the happiest country in the world. They say the key is that they set their expectations low.

I guess trading is the same way. You just set your expectation low. Expect it to be a loser, calculate it to be a loser. Look at it like “Okay, I’ll lose that money in the morning when I wake up”.            

Darren: Yeah and when I have a setup for trade, 99% of them feel wrong to me in the moment they feel wrong to me. That’s why I have a system because my emotions are reacting to small incomplete bits of data. We haven’t got all of the data when we enter a trade. Deep down inside we know that and that is why you get that uncomfortable feeling by pulling the trigger because you know you haven’t got all of the data.

So when  you are operating in that sort of environment, you’ve got to expect some variants in the outcomes regardless of what your system is. If your system is 50% win rate, you can lose 5, 6, 7 or 8 in a trough and you have to be happy working in that environment. If you are not then you’re going to get that feeling that when you lose, it was somehow your mistake.        

Walter: To me, the way I see it, the “correct” answer for me is, if I lose on that trade then the only acceptable reason for that is bad luck. If  that is not the reason, for the reason why that trade was a loser, then that means then that I’m the one at fault. We’ve got to talk, I’ve got to go to the Principal’s office. That is the only acceptable reason for losing trade. It was bad luck.

You get kicked out over the weekend, bad luck. There’s a surprise tweet or something, there’s news release, news comes out hit your stop, bad luck. You’ve got a signal and the signal didn’t work out, it’s just bad luck. That should be the reason, I believe for losing trade.

I don’t think that it’s anything that we do wrong necessarily but if it is execution, if it is in the execution realm, then certainly it wouldn’t be bad luck but then I would say that, “That’s my fault”. If I’m trading my system correctly as I should, the only reason why I have a losing trade is bad luck really.         

Darren: So our strategy is that manage good and bad luck and make the most in periods where we’ve got good luck. Reducing risk and loses when we’ve got bad luck. That’s a big part of our system.  

Walter: That’s right and that’s why stop losses.

Darren: That’s why trailing stop systems works so well because you can’t define how far prices are going to travel but if you can stay in as long as possible then that’s should give you an edge.

Walter: So if you can get more winners on the fat tails and fewer loser towards the fat tails using a stop loss then in theory, you’ve got that edge. Exactly right. Are you ready for the next question?

Darren: I think, a good thing to do as well with that is again, just journal it. Writing down what happened when you had losing trades and writing down what happens when you had winning trades.  

Walter: Right. Do you find that, when you journal obviously you use a pen or a pencil, right?  

Darren: I don’t.

Walter: Oh, you type with a keyboard?

Darren: Yeah and just have threads where I just post every trade. I don’t even go into a great detail. You don’t necessarily have to go into great detail about the trade. Although, it’s showing to help to talk about it. Write down how you’re feeling at the time and how you’re feeling afterwards but just having some sort of record to refer to is good because in your mind, you make up also BS.        

Walter: It basically adds to the fact.

Darren: Yeah with hindsight bias.

Walter: My understanding from the research is that and the reason why I used, what I do is I’d fill up a book and I’ll go buy another nice little journal book. I like getting ones that I like to look at but what I read was that it helps with remembering and learning and processing information rather than typing. Typing is a different process for your brain and I was just wondering if you had try both. If you could compare or whatever.        

Darren: I can’t but Dennis Shaw did a lot of research on this and definitely physically writing down builds stronger memories.  

Walter: Yeah that’s what they’ve found. The studies that I’d been able to dig up. Interesting. You wouldn’t have like some traders they’ll have like a library of ideal trades. So when they’ll look at the trade on the chart, for example if they’re using some sort of pattern, they can compare it to their ideal print out of that pattern and say, “Is this the same? If it’s the same then I’ll take it” but that’s really not what you’re doing, is it?

Yours is a bit more simple and could be argued more robust than that, isn’t it? Because you are just waiting for that turning point. It doesn’t really matter what it looks like. Could you trade the line chart? Would you be able to trade just the line chart without candles or would it have to be candle chart?     

Darren: Yeah, definitely. I could trade the line chart. I had a sort of a debate about this yesterday and about time frames. A lot depends on where your edge comes from. Your edge might come forth from a particular pattern of candles. That might be your edge, you might find an edge in that but mine definitely doesn’t. So it is about knowing what element of your strategy is giving you the most edge and explored in that.

Walter: That’s all the time we have for this episode but in Part Two, you’re going to hear about what big market data tells us about the markets. Why traders have this obsession with the wrong thing and what we should be looking at instead. The one magic fix for all trading systems.

I know it sounds crazy but if you do this, you’ll generally going to be alright with your trading. Why traders are obsessed with the normal curve and here’s a hint: It shows up everywhere even where it shouldn’t be. And, the genius of the low IQ trader. Great lessons for all traders.

All this and more in Part Two of the Two Traders Podcast. See you then!

SHOWNOTES:
Sequence of Trades Spreadsheet

Why do people get into trading?

In this episode of 2Traders Podcast, Darren and Walter dig into the hindsight bias and why you need to be wary of it with your trading. You will also learn about Bayesian Probability, statistics, and a lessons on optimism – might it help or hinder your trading? And what’s the difference between hoping and cheering?

Walter shares a story about risk. And he shares his test results of William Eckhart’s trading concept. Darren shares an interesting idea by Nassim Taleb and how it gives you a better chance of understanding probabilities in your trading.

Download (Duration: 29:13 / 70.1 MB)

In this episode:

00:56 – exciting possibilities
02:10 – times of uncertainty
03:35 – risk thinking
04:41 – destination of pain
06:33 – a bad idea
08:32 – knowing what you don’t know
10:51 – huge payoff
12:59 – big surprises
15:10 – weather apps
18:13 – infinite variants
20:04 – negate or guard against it
21:13 – sound reasoning
24:25 – adjusting risk every week
26:42 – double-edged sword
28:50 – unknown unknowns

Tweetables:
It’s not all about positive thinking [Click To Tweet].
See the real probabilities [Click To Tweet].
Base your risk around every setup[Click To Tweet].

Download The Full Episode 136 Transcript Here

Darren: Or maybe it’s like, think positive but don’t be surprised if it all works out horribly. That’s probably a good mantra, isn’t 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 the Two Traders. Walter here. Hi, Darren!

Darren: Hello, Walter.

Walter: So today’s episode Darren, we are going to talk about the effect of positive thinking on your trading. Do you want me to go first or what do you think?

Darren: I think, I need you to go first on this one.

Walter: Okay. This is the thing I’ve been thinking about. Here’s my theory and I could be wrong. I think, most traders, they get into trading and the reason they get into trading is because they get really excited about the possibilities.

I think that we gloss over the risk and the negative. I think that hindsight bias has a lot to do with that. I mean, I recall myself scrolling back on the charts looking at different indicators like Stochastic or whatever and going, “Yeah, I would’ve taken the trade here. I would’ve exited here.”

It’s almost like, it was totally a mess. It never worked out in real time. That sort of scrolling back and eyeballing it. That was before I even knew forex tester or I didn’t know it was around but I didn’t know about it.

I think that it’s common. I don’t know maybe I just assume that I’m like the average case where we look at things and we think, “Okay, this is a great way to make money. I want to make money. I’ll do this great thing and I will make money” and you forget about the risk.

The other side of it, is I think that some of the best investors think a lot about risk. So, that’s thinking a lot about the negatives when you think about trading. Because the negatives are that, we risk money in exchange, we are getting paid for taking on risk in the times of uncertainty. We’re putting up money in things that are totally uncertain.

We don’t know if we’re going to get that money back and the payoff is we might get more with our money back. So, that’s basically what the trader does. Now I wonder if, people say, “Oh you need to think positive. Being positive is the way to do it. You’ve got to think positive.

And there are all these great correlates that go along with positive thinking and approaching things that way. I think in trading, if you don’t have the yin to the yang, so to speak, you don’t have the risk thing, you don’t have risk in mind, you can really get into trouble.

And the other part of that is, when you see what you don’t want, when you see the negative, it helps you to find what you do want. So that’s why I think we can learn. We make mistakes about looking at things in trading such as forgetting to look at risk or maybe correlated risk or risk of holding a position over the weekend or whatever it is.

We kind of gloss over this risk and then boom! When we learn that is really something important that you need to pay attention to, it helps us to refine what we do want and helps us focus in what we want.

In that sense, it’s not all about positive thinking. I think you still need to have some of the risk thinking. And I know all pessimist will say, “I’m a realist.” I get it. I know that’s true, right? Every single pessimist you’ll ever meet…

Darren: That is true.

Walter: It’s true. You’ll never meet a pessimist who’ll say, “I’m a pessimist”. Every pessimist is a realist. I think that it’s not all about positive thinking. Positive thinking helps in terms of setting goals and expanding your limitations a little bit farther out and that’s great. But, I think that if you don’t have the focus on risk as a trader, you’ll get into big trouble.

I believe that’s why most traders get into trouble. It’s because they don’t understand that what they’re doing will eventually send them to a place where they’ll get really stressed out and they’ll feel helpless. It was actually just, they were already on that road. They were already headed to where they ended up. They just didn’t know that the road they were on was going to go there.

And, if they had figured out the risk side of it, they would’ve known long before they reach their destination of pain that, that is where they’re headed. It is all about understanding that risk part. So, I don’t think that you could just say, “Yey, let’s all think positive and we’ll make tons of money” I don’t think that’s true.  

Darren: Yeah. When you say positive thinking, it reminds me those books in the ‘80’s. Think Yourself Rich. It’s just the case of like, if you’re thinking positively then everything is going to go your way and you’re going to be rich. I think that’s a really bad way to approach trading.   

I think the problem is, like you say, it’s the information that we discount that is the important fit. Generally, we’ve got all of the information but we tend to focus on the bits  we like. The nice fluffy, comfortable bits and the bits we don’t like are the bits that we’re kind of try to block out and discount.

You need to see the real probabilities rather than just the stuff that backs up the outcome you want. I think that is the problem. So in my eyes, positive thinking is probably a really bad phrase to use to your trading.       

Walter: What will be better then? What is the better way to look at it?

Darren: Is it bayesian?

Walter: Bayesian probability, yeah.

Darren: Where you kind of really, you have to look at just because something is highly likely, it’s not guaranteed. Whereas generally, 75% would kind of, that’s a guarantee. I think we fall into that trap a lot in trading.     

Walter: Absolutely. To me, I’m not against like when you’re in a trade, I don’t think it’s necessarily a bad idea to think that, that trade is going to work out. I don’t think it’s a bad idea.

What I think is a bad idea is looking at a trade and thinking, that is such a no-brainer that I should risk a third of my account on it. That’s what I think is a bad idea. You know what I mean?

I think there’s a difference between hoping and cheering on a trade. Envisioning, “I see it on my head. It’s going to hit the profit.” All that is cool. Totally cool but I think the issue comes in when we let that cloud or judgement, which should be based more on probabilities than on sort of feelings.

I always remember, Darren. This was a long time ago and there was a couple of guys, a friend of mine who wanted to get into trading and then at this stage, I just basically moved beyond breakeven. And I was like super excited.

So, everything that had to do with trading I would tell them about. I’m like, “I think, this is going to work” I was really excited. Anyway, so this guy he was like, “Hey, my brother and I want to come over to your house. We just want to talk and see if you can teach us some trading stuff” And I’m like, “Okay. Alright, sure”

You know what was interesting about this — and I’ll never forget this —  I said to them, “Can you tell me what’s some great, what are the best methods for a risk?” “What are the best methods you know of for managing a risk?” You know what they both said?

They both said, independently mind you, they both said, “Obviously, just risking more on the trades where you know it’s going to work out.” You know what I mean? That is exactly what we were talking about here, isn’t it?

Darren: That’s a good plan.

Walter: Exactly.

Darren: Exactly if you know it’s going to work out.

Walter: Exactly, yeah.

Darren: In trading, it is about knowing what you don’t know. If you truly know what you don’t know then you are in a much better place.

Walter: Yeah but you see, the problem is there are known unknowns and then there are unknown unknowns. To quote a certain former Secretary Of Defense in the U.S. So that’s the problem, right?   

There are things that we now, we don’t know which is like for example, what is going to happen on the next trade. We don’t know that. But then there are also things that we don’t know, we don’t know. How do you deal with those? Those are just like black swans, it’s just like out of the blue. What is the contingency for that?   

Darren: Nassim Taleb would say, be antifragile. He’d say, “Have something that prospers from that possibility, that probability rather than in something that blows up”. So, perhaps, you could, let’s say, you work out that risking 3% of your account means you’re never going to blow up based on your data then perhaps risk 1% of your account.

It gives you a greater chance of not succumbing to that but I think there’s a lot of people that don’t agree with that. They think they do know all of it. I think that’s where the danger is. As long as you accept that you don’t know everything and you’ve got a pretty good idea of the things you don’t know then you stand a better probability of making money in this game.     

Walter: Some people also just, it’s so sexy to be able to just pick up and make money every single day not knowing that the one day is coming that is going to completely wipe you out.

Whereas, Nassim Taleb, he’s comfortable losing money everyday and then the big payoff comes some years down the road. He takes the opposite side of it. I think, human nature is, we are not really built for that.  

We are not really built to the point where we can say, “Yeah, I’m happy losing money between today and the nex 5 or 6 years” knowing that one day between now and whenever, 5 or 6 years from now, I’m just going to get this huge payoff.         

Darren: Yeah. I don’t think we are setup to think like that and I think most of the things we do in life don’t necessarily adhere to that rule.    

Walter: That’s right.

Darren: Most of the things we do, we can pretty much guarantee the outcome in our daily life. I think that is the big, not known that is a good idea to take onboard. It’s what the outcome is going to be and not just the outcome today. The outcome in a years time and you can practice and test and have live trading data as long as you want but you don’t know how much money you’re going to make this year.

When you start believing you’re in control of that outcome, I think that’s when you’re in a danger zone. You really kind of have to let the whole outcome thing go and just focus on the process. That is something that we don’t do well naturally as human beings.

Walter: No because we look at the outcome and then we adjust on off of that, absolutely. I would argue that most of what we do as humans is we just draw the straight line like you’re saying.

To me, everytime I look at some sort of article in a business or economics magazine or something, they’re always saying basically like, “This is what happened”. All the banks and all the experts they’re all saying, “Yeah, we kind of expect to keep going.” It’s so funny. It’s like nobody ever learns.

Everyone thinks that, today is sunny. Tomorrow is probably going to be sunny. Last quarter, the market went up. Next quarter is probably going to go up. It’s crazy to me that, that is the case but sometimes you wake up and then the next day, there’s a tsunami. Or sometimes, you wake up and then boom! There’s a nuclear power plant meltdown or you wake up and there’s a revolution or a coup or whatever.

These things happen and yet they’re just not even on the radar. They just come in as these big surprises. I suppose, you’ll go crazy if you had all these anxieties. Worrying about tomorrow there could be a tsunami or whatever.

It’s just crazy to me that the so-called experts, the guys that’s telling us what’s going to happen tomorrow, they just draw a straight line based on what has happened the last week, or the month or the last quarter. It never seemed to be the case where they’ll say, “It’s been going up for five years but we think it’s going to be tank this year.” It’s crazy. It’s just crazy.      

Darren: You know weather apps always give you a 10-day forecast and it’s known without any doubt that their 10-day forecast is basically worth nothing. But they all have 10-day forecast and we all believe them and we buy into them.  

Amount of people have come up to me ad say, “Look, in 10 days time, it’s going to be 25 degrees and blaze in sunshine.” You can show them the statistics and say, “look, it’s really, really inaccurate” past ten days. In fact, weather reports have only really accurate for sort of 24-hours. Still can’t believe it, you still can’t buy into it and then that’s how we think.          

Walter: Yeah, I totally do. I totally fall victim to that. I’m like, “Oh yeah, 8 days from now it’s going to be raining so I won’t do this. I’ll do that” and then it’ll come up and I’ll be like, “Are you kidding me? It’s supposed to be raining today. What?”    

Darren: Usually it’s because there’s some sort of an event going on in their life that they want to have a good outcome. Maybe they’re going camping or something and they’re attached to that one particular outcome.

So when you’re in that kind of mindset, any data that comes at you just bounces off. You’re not going to take that. Your mind’s made up, it’s going to be sunny when I go camping. It’s says on my weather apps. So whatever you tell me now, fact or otherwise, is just going to bounce off me.

I think that’s the key system that you have to build into your trading is, some way to rationalize that. A different way of thinking about outcomes. If you can do that and you can get good at that then it will improve your trading ten-fold.

Walter: So how do you do that? How do you think about outcomes?  

Darren: Let’s say, I’ll cast my trading strategy that has a 50% win rate. When I enter a trade, it’s no good than instantly thinking that it’s going to be a winner and acting based on that emotion. You have to be realistic with your expectations.

So, you have to say, “This has got much chance of being a loser as being a winner “ and there’s going to be variants in there as well. If I have 3 winners on the trough, that doesn’t mean that my win rate is now suddenly a 100%. It’s still 50% but you just happen to have about 3 on the trough.

It’s kind of this idea of thinking in bets and looking at all the information and being realistic with your expectation. I don’t think you have to be particularly clever to do this. It’s just kind of a personal choice. I’m going to be a little bit more rational about what I’m expecting and what the possibilities are.

That can go a long term data as well. You can have ten years of data that says that your returns are going to be an x amount. There could be a massive variants in the next ten years.              

Walter: Yeah.

Darren: You have to accept that.

Walter: William Eckhart talks about that in the New Market Wizards. Actually, I’ve tested what he was saying. It was exactly what you are saying, Darren. He says that, for example, you have a 50% win rate.Sometimes what you’ll notice is that the actual data, the actual trade results will get away from that 50% mark and they will stay away from that 50% mark for a long, long, long time.

So you’ve tested your system. You have a 50% win rate and then here you are, 3 years into trading it live and your win rate is at 48%. It could stay at 48% for years. It may not get to 50%. You may die before it gets to 50%.

So if you’ll get really aggressive with your risk or if you make any sort of mistakes based on assuming that 50% win rate, you can get into big trouble and I’ve done this with random numbers.

I’ll dump them into the spreadsheet and just see like, if you dump a 1 through a 100 into a spreadsheet, you can just make it randomly assign 50 to 100 as a winner, or whatever 51 to a 100 as a winner and 1- 50 as a loser. You just do that and see how far away can it get from the true mean, which is assumed to be 50% and what happens. And then it happens. It does happen exactly like you said.

And so, what he says, is that we have in the markets, we have infinite variants and everything in statistics is not assuming that. Every normal curve you’ve ever seen, every statistical test you’ve ever seen in your life, all that stuff, assumes a normal curve distribution. Which means that only occasionally do we get those outliers on the tail.

We don’t have fat tails and what he’s saying is that not only do we have fat tails but we have really fat tails. I believe it. I’ve tested it. I think I’ve mentioned this before, probably in an episode a long time ago where I look at Swiss Franc and I said, “Okay, let’s look at Swiss Franc. Let’s see the distribution of the prices and is it true that we would have, the distribution of the Swiss Franc prices fit the normal curve” and the answer was no.

It was 300% more variants in that distribution. And that was over like 3 years or something like that. It wasn’t even a big sample. I think that you can make the case quite easily that we have such variants in the markets. Even if you don’t want to say that it’s infinite variants.

There such variants in the markets, that means the market can move really fast, really quick and you have to decide what you’re going to do to counteract that. What are you going to do because that means you can get literally wiped out.

It’s just crazy. That’s one of the things I guess. Thinking about our main topic I suppose. We don’t think of that. As a trader, you think positive, “Okay, it’s going to be a win or a loss” you don’t think in terms of this huge variants that’s out there so you can decide to take advantage of it like Taleb does. Or you can decide to try and negate it or guard against it.

Be aware that it’s going to happen but that is why I think it’s crazy to give all your money to one broker or it’s crazy to put, let’s say, you have x dollars for trading, you don’t want to put all of that money in with your brokers. That’s crazy too. There’s risk everywhere and it’s just not, to me, we just forget it. It’ too easily forgotten.  

Darren: Yeah so really the message isn’t think positive, is it?

Walter: No. I guess not.

Darren: Well maybe it’s like, think positive but don’t be surprised if it all works out horribly. That’s probably a good mantra, isn’t it? It’s basically saying, the one thing you don’t know and you need to forget about is the outcome. You need to focus on other areas.

Walter: What can we control? We can control process and execution, right?

Darren: Yeah, those two. And there has to be sound reasoning behind your process and really kind of get into the area of edge. What is your edge and how sound is the reasoning for your edge?     

Walter: Are you focused on making sure that the way that you interact with the markets will pull out that edge? In other words, are you executing a sound manner so that your edge will show itself? Because we get in the way, I guess.

Darren: Definitely.

Walter: Cool stuff.

Darren: I did it last week. I started trading my stop earlier than I normally would and I’ve convinced myself there was a sound reasoning for this. It end up causing me a lot of profit. I didn’t lose any money but it caused me a lot of profit. I basically took my edge away.

Walter: Which is more painful: to lose out on a potential profit that you should have had — the missed opportunity — or is it to lose money? To actually lose money because of a mistake. So the mistake causes you to lose out on more profit or missed opportunity or the mistake causes you to actually just lose money.

Darren: I run a very low win rate system so for me, it was missing out on the winners because I don’t get many winners. And, execution mistake that takes one of those away can really damage my outcome in the long run.

Whereas, loses happen a lot and I should’ve set my position size correctly that they are not going to matter so much. So, for me, it was missing out on the winners. That was the painful thing.

Moreover, the fact that the failure was in me. The system was clear. I know what I needed to do and I break the rules. That’s the most painful. I can’t blame it on anyone else. I can’t blame it on the markets. I’d like to blame it on the markets but it was me.  

Walter: Let’s say, you’re in a trade and you calculate, because what I do is, if I’m in a trade and then I’d take another one, I calculate my risk assuming that the trades I’m in currently are going to be lost. They’re counted as a losers. Do you do that or how do you manage your risk? So, when you’re calculating your risk, what do you do with the open positions?     

Darren: My risk is based around I take on every setup.

Walter: Right. For example, let’s say, you have 5 positions on and you’re taking a 6th position, would you assume that those 5 previous positions are like, let’s say, you’re risking 1% per trade, do you just assume that those previous 5 positions were all 5 percentage lost or how do you do that? Or do you just keep the risk the same or do you adjust it every week or something? Is that what you do, you adjust the risk every week?        

Darren: Only up. If I’d make profit then I’d compound it but if I made loses I don’t.  

Walter: Right, you keep the same risk.

Darren: Yes, I keep the same risk. So, if I have 5 trades open as far as I’m concerned, they’re gone. To be fair, I’ve never gotten to the point where I got 6 trades open with these strategies.   

Walter: So you would go like, We’re up 10% off of last week, — so you go — “Okay, now this is our new risk amount” and then all week long, you’re using that amount. And, let’s say you’re down 2% on the week, the following week, you’ll keep the same dollar amount or pound per trade risk.     

Darren: I’m not an expert on risk and I need to do a lot more studying on it and I wouldn’t advise anyone to take my advice. I may well be doing it right based on the data I’ve got then it works good enough. I try to stop trying to optimize. Stop trying to be at the maximum all the time and try to find a place that the works good enough and be comfortable with that.      

Walter: Gotcha, cool.

Darren: Again, whether that’s the right thing to do or not. I don’t know but I think you can. Optimizing can help but again, you don’t know what the outcome is going to be. So you test 3 years and workout you can risk 5% and risk 5%. It could be too much. You could just have 3 really good years.

If you’ll look at some like Dunn Capital who go a whole year and make a loss and then the next year makes 30%. He makes massive returns but there’s a lot of volatility in his returns. He’s probably not best to optimize on one good year of data. Optimizing is a double-edged sword and you need to be careful with it.

Walter: Absolutely. The systematic traders are very aware of this but even discretionary traders need to be wary of this. It’s a common thing. The best example I’ve seen of this is the book — and I’ll put in the show notes, I mentioned it before I think. — The Holy Grail or something like that.

It’s like some books on Kindle and these guys got together and there was like this A-team of traders. They all met in the forum. They’re on some forum on the internet and they basically came up, they concocted this strategy and they really build up their account really quickly.

They’ve got really aggressive with risk and everything. What they didn’t realize though is, they basically optimize everything on the Euro during the first 6 years of the Euro. So, it was just an uptrend more or less.

So, when the Euro first came out, it was in a straight downtrend and then it immediately reversed of that. Basically went roaring essentially in an uptrend and so, what they didn’t realize is that everything that they had come up with was based on these data. On the Euro because they were just trading the Euro which is basically just trending in one direction. They’ve got into big trouble and essentially they’ve lost it all.

But, that was based on what you’re saying. In this instance they took all of the data available. They were trading the Euro, they’ve took all of the data they had in the first 6 or 7 years of the Euro or whatever it was. ‘99 to 2006 or something like that and they still made a mistake.                  

Darren: Again, they’ve bought into the outcome and even if you have all the data available, it doesn’t mean that you’ve got all the data. I think that is the take away from this. Be positive but accept that you don’t have all the data.    

Walter: There are definitely unknown unknowns. Thanks so much, Darren. This has been a great episode and I can’t wait to see you next time.

Darren: Okay. I’ll see you next week, Walter.

Walter: Bye.

What trading advice would you give your younger self?

In this episode of 2 Traders Podcast, Darren and Walter talk about the “DeLorean” effect and whether it can help, or hinder you trading.

Darren would tell his younger self to find this really old book and do this one thing (listen to hear what he says). He also shares his insights into making mistakes and the reality of trading.

Meanwhile, Walter takes us back down the memory lane of what happened years ago regarding trading through the technical analysis lens. Walter claims you must do this one thing to advance to trading consistency.

Download (Duration: 21:42 / 52.1 MB)

In this episode:

00:50 – Back To The Future
01:46 – losing, struggling and starting
02:32 – simple core ideas
04:56 – No-No-No-No-No!
06:47 – early bird gets the worm
08:01 – don’t glare on the sun
09:50 – good money after bad
10:35 – patience is a big deal
12:07 – small failures build up
13:34 – the secret
16:58 – the big thing
18:51 – end of the line
20:36 – the right mentor, the right approach

Tweetables:
Understand your psychology [Click To Tweet].
Lessons are learned by failing. [Click To Tweet].
Markets are designed for the patient[Click To Tweet].

Download The Full Episode 135 Transcript Here

Walter: You know, systems aren’t nearly as important as understanding what you’re doing with your trading. Like we’re talking about, it’s the Psychology of really understanding your psychology. Once you understand “You”, in the end, most traders I think come to that conclusion. I really believe that.

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 the the Two Traders Podcast. It’s Walter here. Welcome, Darren!

Darren: Good morning, Walter.

Walter: So Darren, we have this idea. This topic is, we fire up the old DeLorean. What was that?

Darren: Back to the Future.

Walter: Yeah, back to the future. So you fire up and go back in time and as the sage trading adviser, you say, “Hey, this is what you really need to know about your trading”. What would you go back in time and tell yourself, if you’ve had an opportunity?

Darren: It’s a bit of a difficult one to answer really because my first instinct was the obvious stuff. And then I did sort of think a little bit more on it and I thought, I wonder whether it would be a good idea to go back and tell yourself anything.

A lot of the best things, best lessons in trading, all of the things that are most important to learn, are things that maybe can’t be taught and have to be learned. Learned over a long period of time through a lot of losing and struggling and starting again.

I think some of those subtle lessons that you need to pull together are those personal skills. Even if someone tells you this is what you need to do, you have to go through the process of learning it yourself.

So that was one thought but if I did go back and I had to tell myself something, I’d probably suggest say, one book. Find the oldest technical analysis book that is still in print. Read it twice and then put it in a drawer. Forget about it because that’s all you need to know about technical analysis and stop learning about it. Then, you’ve got all you need to know about technical analysis.

I don’t think there’s anything new now that wasn’t known before. We are just essentially taking the simple core ideas and coming up with new ideas based on them. So if you understand those basic core ideas you really know everything you need to know about technical analysis.

Walter: Yeah.

Darren: I’d probably tell myself one quote a well. I think the only trading quote you really need to know – this is my personal opinion, is – “Cut your losers short and let your winners run.” Jesse Livermore, I think that was?

Walter: I think so. I think many people have probably said it, yeah.

Darren: Yeah, I think it applies to all trading systems and that encompasses the idea behind trailing stops. The idea behind not holding on to winners or not holding on to losers or adding to losers. I think that’s really important.

I would have taught myself one thing. To continue studying, it would be human behavior and Psychology. Why you make decisions and how you make decisions and how to improve that process. How to build strategies that deal with those issues as well.

Those would have been three simple lessons that I would have tried to teach myself. Whether I would’ve listened or not is another thing, because I probably wouldn’t have changed my mind. Going back comes over a long period of time. Lessons were learned by losing and failing.

Walter: Yeah, that’s a good point.

Darren: So, what about you?

Walter: Well, you’ve got me thinking now about this idea about learning your own lessons and that sort of thing. I suppose, it’s interesting what you’re saying about finding the oldest book on technical analysis and put it in a drawer.

A couple of years ago, there was a group of traders together. One of the traders, was quite good but he had this feeling that he needs to learn more about technical analysis. He said even though he had a system and everything he had it all lined up and everything was good. He said, “I just feel like, I’m missing out. I need to learn and get more well rounded.”

You know what everyone said? All the more experienced traders in the room said, “What are you doing? No-No-No-No-No!” They all said, “Don’t do that!” It was really interesting. It was fascinating actually to see all of the other traders, myself included say, “No! Don’t do it.” Don’t you mess yourself up basically was the the main message and it kind of reminds me of what you’ve just said.

Darren: You also need to ask the question, “Why do you feel you need to know more technical analysis?” You always have to reflect on yourself and analyze why you’ve got questions in your head. Where they’re coming from, what is the root cause of them.

Walter: Yeah, I remember when I was studying Religions in a University, it was my minor. I  wanted to see how did all the religions deal with the big questions – Why are we here?  And all that sort of thing. And I just thought it was really important to me to see all of the different perspectives. But, I can see in trading it would just be a real mess.

It’s sort of like changing your sexual orientation or changing your political bent, or something like that. I can see where it would really mess you up, when it comes to trading. You almost need to adapt a certain way of seeing things and just stick to it. At least that’s my feeling, anyway. I don’t know that you get a lot out of exposing yourself to different ideas. I didn’t know that there’s a lot of value there.

Darren: Well, I think there are only a few simple big ideas. When you start to delve into them, you kind of realize that it’s like the saying, “The early bird gets the worm.” Implying that you need to be early. But, the early worm gets eaten so it depends where you’re…

Walter: Where you are in the food chain.

Darren: Yeah! You might prefer like value entries. You might like buying stuff when it’s really cheap. At the same time, you may prefer buying things when they’re rising in value quickly. Buying with momentum. They’re two opposite ideas but they’re essentially the same thing.

When you can study those two core ideas and if you build a strategy with two different entries – One has a value entry and one is like a break out entry.  You start to realize that there really isn’t a great deal of difference in them. Then you can start to simplify the technical side of it. And realize that it is an important part of trading but it can only get you so far. When you know that, you realize that you don’t have to keep learning about it.

Walter: Makes sense. I guess, if I have to tell myself one quote like you said — you had the one quote — I would say, “You don’t glare on the sun.” To be honest with you, I’m not really well-versed in all the Warren Buffett stuff. I haven’t read his books or things like that. Just because I don’t see him as a mentor or someone that I aspired to be because he does things different to what I would do or what I’m interested in doing.

But, I do believe that what he said, and Denis in France was the one who brought this to my attention. The quote was, Warren Buffett said something along the lines of “Markets are designed to pull profits, or pull money away from the impatient and give it away to the patient.” I just thought, that was so true.

If you think of a lot of things in trading like, who are the impatient ones? The scalpers. Who are the impatient ones? The ones who are taking their profits too early. Who are the impatient ones? The ones that need to get in right now and don’t want to wait for the signal to actually fire off. They get in 15 minutes early or whatever.

It just seem to fit so well. Even from a crowd psychology point-of-view: Who are the impatient ones? The ones that are following the crowd or following social proof, which is what everyone else is doing. “I got to get in now, I can’t wait.” That sort of thing. I just feel like it’s such a great way of encapsulating what the markets do.

I know it’s not perfect but it just seems to make such great sense in so many different ways. I’m sure that there are places where it doesn’t fit, but this idea of impatient people throwing their money. You know, good money after bad. To me, it just really fits.

Also, I’ve noticed in my trading, if I miss a signal. Let’s say, that I want to trade a H4  chart. For whatever reason I get home late or something, I check the charts and that H4 signals are already printed.

Often times, not taking the signal on the absolute close of the candle when I should have taken it, and instead having a little bit more data there on the chart, will often help me: One, to avoid a bad trade. Or two, get in even better on the trade, on the signal.

I’m a big fan of letting the market give you a little bit more of information and not feeling like you have to go in right now. For me, patience works that way. I think that patience-thing is a big deal.

You brought us some good points about learning your own lessons. I suppose, the best lessons – I often wonder is it possible that the lesson where you lost $5000, you know you learn more from that, than the one where you lost $50? I wonder if that works.  Does the math work on that.

Because it could come down to, it could depend on what percentage, how much is that means to you. When you lose the $5000 that might not mean nearly as much as when you lost the $50, 15 years prior. It could be what your situation is.

I just tend to think that there are certain situations where the mistakes that you made, is kind of easy to burn those into your arsenal, into your tool chest, into you learning. And then in other instances, it’s easier for you to gloss over those and just say, “You know what? That was because of this and that.” And not really attribute it to the right reason why you made that mistake. Does that make sense?

Darren: Yeah, it’s almost like we don’t really learn the lesson until it gets really painful. I suppose that could be true. But I think, small failures build up over time as well. I kind of like that rather than one massive crash if you’ve had a few years of repeating the same small mistake. It’s like the difference between the long term memory and the really sort of shocking memory. I think they are both easier to learn from.

Walter: Definitely. I always think of the stories of the traders that you read and they talk about the one big mistake or the one lesson that they learned when they took on too much risk or whatever they did. It’s so interesting to me. And then you see people like Jesse Livermore, who has never seem to learn from their mistakes. They keep making the same mistakes over and over again.

Darren: Yeah and he knew he was making those mistakes as well but continue to repeat them.

Walter: Would you say that he wasn’t cut out for trading? I mean, people hold him up as this great trader but in the end I don’t know if you can really say that. This great trader in the end just kind of did himself in, quite literally because of where he was at. It’s just not a nice thing.

Darren: I think, it’s probably psychology and personality that he had a problem with. But I think he could have put systems into place to counteract that. The secret is knowing what you don’t know and knowing what your mistakes are. And then, being able to design a system that incorporates that and stops it happening. I think that’s the real secret.

I think when get to have those elements right together, you’re in a much better place going forward. You’re increasing your probabilities of being profitable. I think perhaps maybe the traders who do really become consistent and profitable, they have either consciously or subconsciously built a system that deals with their failings.

Walter: Yes. I think that’s the key. I think the traders who do well know how to deal with failure, basically. When you’re talking about these systems, do you think that it’s easier if you have somebody else helping you with that? Or do you think it’s okay like some traders can just do it on their own?

Darren: I think you need a checklist. I think, just sitting on your own and saying, “I’m smart enough to deal with this”, is probably the least effective way. There’s two proven good ways of dealing with it or two tested ways of showing to give good results. Writing stuff down, some sort of journaling and the other way is, like you say, having somebody that you are accountable to, who is going to question what you’re doing.

Like on trading floors they’ve found that, if they have good managers who speak to the traders and tap into their emotions and get them to express their emotions. Which is similar to writing stuff down. That’s an expression of emotion. Those are proven and tested effective ways of doing it. That can happen in many ways.

It can be just running a journal on a thread where you just post every trade. You don’t need to discuss what’s necessarily is going on there but you’ve got some sort of transfer of what’s happening inside you onto some sort of written journal.

Walter: Yeah, then when you go back on that first of all, if you do that on a forum or whatever, it’s kind of good because you’re almost committed to it. Like you’ve got to keep going. Once it’s going, it’s going. Then you go back and you learn so much.

When you go back and read it, “Wow, I can’t believe.” It’s a lot like journaling, but you are a little bit more exposed. And you can leverage the experience of others, if there are people that you trust, that you respect, they offer some advice. Sometimes you can incorporate that as well.

Darren: Definitely. I will often get to the end of the week and feel inside myself that I’ve traded and executed fairly well. My systems pretty systematic. There’s not really much leeway in what I need to do and when. But then, just going back and looking at the individual trades that I’ve posted, I kind of realized, I actually made a few mistakes there. Common mistakes which you shouldn’t be making anymore. So that’s a really good way of dealing with it.  

Walter: Anything else that you would like to say to your younger self about trading? I guess I would say, patience is the big thing. The other thing would be, systems aren’t nearly as important as understanding with what you’re doing with your trading. Like we’re talking about the Psychology of, really understanding “your psychology”. Once you understand You. In the end, most traders I think come to that conclusion. I really believe that. Most people would say, “That’s it. That’s me.” It’s self reflection, it’s understanding your issues that’s what it comes down to.

Darren: Yeah. If you could have gone back and pushed yourself in that sort of direction, I think that would have been really helpful. The only question that remains in my mind is whether you can learn that quickly by somebody telling you or whether you need this kind of long term memory of failing, when you’re going against those principles.

Because I do remember back when I started trading, there was a lot of stuff about Psychology. And I just made a mental note, “Yes, Psychology is important”. I didn’t really do anything more about it. I’ll just file it out at the back of my head and continue doing what I’m doing. Even when you can see in front of your eyes that your back testing ideas, you’re working out what makes them tick and then you’re doing the opposite in your life trading.

Even then, it takes a long time for that to sink in. But you know, the thing that I never did was really have somebody to be accountable to who would say, “Look, you’re lying to yourself here. You’re saying you are going to do this but it’s not what you’re doing. What systems are you going to put into place to stop that?” For me, it was just a case of getting to the end of the line and thinking, “I can’t do this anymore. I’ve got to make some radical changes”.

Walter: The traders when they leave the bank desk they always think that they’re going to do well. They’re going to trade their own money and all these so often, they just fall apart because they don’t have that structure in place.

You were saying before about, how do you know if you would just take a lesson that someone gives you versus having to learn it repeatedly or picking up that experience over time. I feel like it depends on the person. I feel like I’m a pretty good student. If I had made the decision earlier on to seek someone out and just really listen to what they said, just let them mentor me then, it probably would have shortcut for me.

I don’t know if that is for everyone. I don’t think that’s necessary the norm. I just think that I’ve kind of trained myself to be a student. I’m good at copying stuff. Which is basically what our whole Western school systems are like. Copy stuff and then spit it back out.

It’s ridiculous but those are the ones that are rewarded. I think some people wouldn’t do that well. I know people like that. They would be like, “Ah that’s B.S. I’m not going to do what he says.”

In fact, I did that with my own friend, who got me into trading. He was a good trader. I just said “What you’re doing is crazy. There’s no way I would ever trade the M5 chart like you do.” I said, “No way!” I just knew right away that, that was not what I wanted to do. So I guess, it depends on getting the right mentor, the right approach. I suppose.

Darren: The point that you brought up about making big mistakes, there’s a book that’s just about to come out called Big Mistakes: The Best Investors and Their Worst Investments on this topic. Michael Batnick I think, is the author. That’s on that theme as well.

Walter: That’s cool.

Darren: Thankfully, I’ve never made big mistakes. Or maybe I have.

Walter: Big Mistakes, you said? I’ll have to check that out. We’ll put that in the show notes for everyone so you can find that one if you’re interested.

Thanks so much for your time Darren, I really appreciate it. I guess, we’ll see you in the next episode.

Darren: Okay, Walter. I will see you then.
Walter: Thanks.

SHOWNOTES:

“Big Mistakes: The Best Investors and Their Worst Investments” by Michael Batnick