2TradersPodcast

with Walter and Darren

EP138: Compounding Your Trades (Part 2 of 2)

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…

http://media.blubrry.com/2traders/content.blubrry.com/2traders/2Traders-EP138_Compounding_Your_Trades_Part_2_of_2_.mp3

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.

EP137: Compounding Your Trades (Part 1 of 2)

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.

http://media.blubrry.com/2traders/content.blubrry.com/2traders/2Traders-EP137_Compounding_Your_Trades_Part_1_of_2_.mp3

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

EP136: The Effects of Optimism

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.

http://media.blubrry.com/2traders/content.blubrry.com/2traders/2Traders-EP136_The_Effects_of_Optimism.mp3

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.

EP135: Trading DeLorean

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.

http://media.blubrry.com/2traders/content.blubrry.com/2traders/2Traders-EP135_Trading_DeLorean.mp3

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

EP134: Perception Reality

Have you ever been in an uber-focus mode and everything else is just a blurry haze?

Darren and Walter dive into the rabbit hole of perception this discussion.

Walter talks about the two critical pieces for your trades. He talks about how the National Football League is similar to traders who automate their strategy.

According to Darren, human behavior can sometimes “alter” reality and your beliefs can impact the trading game. He also shares an interesting idea by a well-known poker player on probabilities and talks about visual illusions.

Are you seeing what you think you are seeing? How might this alter your trading results?? All this and more in this episode of 2 Traders.

http://media.blubrry.com/2traders/content.blubrry.com/2traders/2Traders-EP134_Perception_Reality.mp3

Download (Duration: 25:45 / 61.8 MB)

In this episode:

00:12 – hazy in the background
02:01 – suit of armor
04:27 – visual illusions
07:44 – a reason or a narrative
09:05 – final decision
11:07 – human behavior
13:45 – fastest way to lose money
15:15 – ask a reporter
17:17 – bowling alleys
19:34 – gimmicky or lucky
21:35 – marry your thoughts
24:20 – too quickly

Tweetables:
Clarity comes by not having skin in the game [Click To Tweet].
Build systematic rules [Click To Tweet].
Is trading about changing beliefs?[Click To Tweet].

Download The Full Episode 134 Transcript Here

Darren: I realized that when I’m looking at a chart, my eyes are just picking out the patterns that I’ve predetermined I like and the rest of it are kind of hazy in the background and you’re not considering 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 back to the Two Traders. It’s Walter here and I’ve got Darren on the line. Hello, Darren!

Darren: Hello, Walter.

Walter: Welcome back, Darren. So, we’re talking today about perception reality. The question is this: Is perception reality for traders? If so, why this matter? Any thoughts on that? What are your thoughts?   

Darren: I don’t know. What’s your thoughts on this?

Walter: Okay, I’m happy to go first. I think really what’s going on here, my thinking of this when I think about this is traders basically have a really difficult time. And this is not an indictment of a trader but all people really, have a difficult time stepping out of our theory or the way that we see things. This is kind of the root of the confirmation bias.

And so, it’s really hard for us. Like, if you think the economy is going to collapse then every chart you look at basically says, the economy is going to collapse. Likewise, if you think that gold is going to go to the roof, then everything you look at sort of, is tainted to that way. So in that way, our perception becomes reality.

The real concern here I think, there’s two things that are important here. One is, when you take a trade, can you step out of your suit of armor so to speak and say, “Alright, who’s the other guy on the other side of this trade? What is he thinking? What does he see?” Or, “What does she see? Why would she take the opposite side of my trade?”

And then, the other bit of it is I think that is really a useful exercise to look at it from the other point of view and come up with a case for why someone would want to take the opposite trade.

The other part to this that I like is that it’s so much nicer to get out of a trade and then analyze the chart. It’s so difficult I think for traders when they’re in a position like, if you long the EUR/USD and you’re trying to figure out if it’s double top or whatever, or there’s a reason to get out of the trade, it’s difficult. It’s much easier if you’ll just drop your position and then decide.

In other words, clarity comes by not having skin in the game I guess, is one way to look at it. So, what are your thoughts?               

Darren: I think I like Annie Duke’s way of approaching these things where she says, to think in terms of probabilities all the time and to sort of understand them rather than looking at a chart and saying, “Right, it’s definitely going to go up here and it’s going to hit 1.3” or whatever.

Rather than doing that, you think in terms of what the probabilities of it going there and then being kind of realistic about them. Even if you think it’s a 70% chance that I’m right, you’re allowing the notion that you’re going to be wrong as well. Rather than seeing it as black and white.

Walter: Yeah.

Darren: So this is my analysis and this is definitely what’s going to happen. Even if something should you know, 90% then it’s not going to happen all the time. I think that is a better way to approach it.

Certainly, the element of it that always fascinates me is the way that what we visually see plays tricks. I’m really a bit fan of visual illusions and I’m always searching out for those. That always just kind of sits in the back of my head.

I realized that when I look at the chart, my eyes are just picking out the patterns that I’ve predetermined I like. The rest of it kind of hazy in the background and you’re not considering that. So, I particularly like the visual upside of that idea.    

Walter: I think, it’s really useful to like, when I’ll look at the chart, I usually and I’ll even say this in my videos. I’ll say, “If this happens” — that I think this scenario is more likely — “if this happens in this scenario” you know what I mean? The next piece of data that comes through, it points to which path we’re on, so to speak.

Darren: Yeah, definitely. I think that’s why, like we were talking about earlier, why systematic wins over discretion.   

Walter: Right.

Darren: Because you should be able to build systematic rules around that and if you can’t then it means that you haven’t either, haven’t got enough data or you’re just falling to confirmation bias. You’re just looking for the stuff that agrees with what you believe is going to happen    

Walter: What do you think about — I know this is kind of tangential but what do you think about — those guys who build these automated systems that say, they kind of let the machine come up with the rules. They’re not really in control. They’ll just throw a bunch of data in there and then the machine comes up with, “Okay, this is a pattern that we find.” The machine find the patterns that you know, you bought 330 on a Tuesday. Chances are, it is going to work out.

They come up with these things that you can’t look over the reasons why would it be the case but it just happens to be the case. What do you think about that? Is that acceptable as a system building? Or does it have to be logical except that it has to make sense to you as a trader?        

Darren: No. I think the approach is the same really. It’s looking at data and working out probabilities and working out a mathematical edge. If that appears to be there over a large set of data then really that is the sort of basis of what trading should be. Unless, you believe in forecasting and it’s a case of you being able to decide where prices are going and you’re being right.        

Walter: Some traders will just say exactly what  you’ve said which is, “Look, if the Euro makes a new low every time the new moon comes up then, I’m just going to trade at the new moon.” Other traders are going to say, “That makes no sense whatsoever. There’s no way a new moon ever do that. Doesn’t make sense.” That makes up the market, I guess.

Darren: Yeah. I suppose as human beings, we kind of want to be able to find a reason, a narrative for how it happened.

Walter: Yes.

Darren: We want to find that but it’s quite possible that computers can find that there’s reasons as well. It’s quite reasonable to accept that.

Walter: Yeah, they’ll find the patterns and they’ll find the solutions probably way better obviously than we could possibly do so or it’s approaching that any way. Here’s the similar thing. So the United States, in the football league, they have 16 weeks of games.

And so, the opponents are set but the schedulers have to come up with a way where everything fits. Some of these stadiums, they’re sharing them with baseball teams or there’s concert or whatever they were booked in advance. So, they’ve got to work it out so that all of these teams play a schedule in a fair way. Where they don’t have to play 5 away games in a row or whatever.

Basically, what they do is they have the computers spit out all of these different versions of the potential schedule and then they’ve kind of whittle it down. If the computer does the hard work, the humans just in the end sort of end up making the final decision.

I think, that is how a lot of traders who use these automated strategies, you put all the data on to the computer and the computer spits out and say, “Here’s a profitable system.”

I think a lot of traders they’ll just look at it and think, “Well, buying EUR/USD every Tuesday at 3:30, I don’t know.  It doesn’t make sense. Why would I buy the EUR/USD?” “Buy the EUR/USD everyday at 6 pm, why would I do that? It doesn’t make sense. What’s going on in there?”

But, if they can come up with a story, if they can come up with a narrative like you say, then all of a sudden, everything is fine.

Darren: I think you’ve kind of got to have an idea of which stories are worth basing your evidence on which are not. I think in markets now, we understand that really the good evidence stems from human behavior. We are much more switched on to that now.

Although, these books from the ‘30’s which were all written about human behavior and markets but I think we’re giving it more precedence now. I think for awhile, technical analysis took over but now it’s more about human behavior. That is what I believe anyway.

Walter: Do you think technical analysis is a way of looking at human behavior?

Darren: I think it is but that doesn’t mean that all of it is.

Walter: I agree.

Darren: I mean, there’s technical analysis that works because of human behavior and then there’s stuff that’s really out there and it’s very hard to tie it to that. Trends for example. A trendline or a moving average or retraces in trends. Elements like that can be tied to human behavior.

The two actually work together really well. I know it seems like sometimes I’m negative on technical analysis but it’s more a case of being realistic of how important it is or how precise it can be. I think this notion that ultimate technical analysis will give you precision. I don’t think that is possible to achieve and that’s really what I argue against.       

Walter: Right but if technical analysis enables the trader to feel like he has precision, there’s a value in that.   

Darren: Possibly. I think it’s probably a bad mindset to take to trading because when you’re having inevitable losing run, you are likely to react badly to it. Rather than just accepting that it’s not a precursor and sometimes it’s not going to work out. You need to remain steadfast and systematic and continue to trade.    

Walter: My daughter when she’s convinced that she’s hurt, if I gave her a bandaid it makes everything better. I don’t think it really does anything medically for. It’s just psychological. I guess, it’s the same idea with technical analysis.

It’s like, “Okay, let’s do this and we’ll be precise about our positions” maybe it’s not true. Maybe it doesn’t actually do that for us but it gives us the illusion of control. I think you can see that there are many different technical systems that will enable you to see. For example, exuberance in the markets or fear or something like that. I think that’s quite valuable that you can see that.

That emotion will pop on the chart when you use certain types of technical analysis. So, it’ll become quite obvious that, “Look, there’s exuberance here. This market is really stretched.” Same with fear. You could see that and it’s quite obvious and so that becomes useful.

Even if you’re just to use it, just for that for example. If you’ll just to use that for that. I think, it’s interesting. If I were to just and I know traders that do this or at least I know one trader that does this.

If you were just to read for example, the newspaper. Like if somebody just said, “You know what? I’m going to start investing in the markets and you know what I’m going to do? I’m just going to read the newspaper. Whatever the newspaper suggest I do, I’m basically going to put my money in it.” I think that would be pretty much the fastest way to lose money.

I can’t think of a better way to lose money than just to like read the business paper or the Economist or something like that. It just seems like that would be the perfect recipe for losing money.

The reason I bring this up in regards to technical analysis is because that is essentially the opposite of looking for fear and exuberance in the markets which you can see with technical analysis.

If you’ll just go by what the financial writers are writing about, I think you’d be much more likely to follow the crowd.That sort of reporting is largely, not completely but largely about what the trend is doing. What is the crowd doing right now.

It’s only later on after the peak that they’ll ride about it. It’s kind of that. I have friends who write and they’re telling me that their Editors tell them now that you’ve got to talk about what’s happening next. It’s not enough to just report on what is happening but you’ve got to also talk about what’s going to happen next.

Which is interesting because I think that when you look at research along these lines, you’ll see these too in Psychology. Most people think that whatever is happening today is going to continue to happen in the future.

If you’re asking a reporter, a finance reporter with an Economics degree or whatever, to report on what’s going on in the Economy or in the markets. And then, you’re also asking that same person to project into the future, which is apparently what the Editors are doing. It’s not enough to report.

So, what they’re doing is they’re just saying, “Well, this is what’s going on” and basically we expect it. They’re most likely to say, “and we expect it to keep going” and it just seems a recipe for failure.

Darren: Yeah, everyone who bought Bitcoin at 18,000 would in that boat.

Walter: It’s crazy, isn’t it? Absolutely crazy.

Darren: How do we go about a  good perception of markets and having a reality? What are the simple steps to take to having a reality that gives us an edge?

Walter: I agree with you in terms of the data. I think the first piece is you’ve got to convince yourself. That means collecting a lot of data. Once you’ve done that, you’ve convinced yourself, “Yeah, there’s an edge here. These series of rules or this way of interacting with the markets works. I have enough data here that support this theory and I believe this to be true.”

I think it is also important that it matches up with what you believe about the markets in general but some people just look for what works. I don’t think that’s the long term path to success as a trader.

I don’t think you should be looking for what works. I think you should be looking for what you believe will work. You find that data then you go, “Okay, this seems to work” and then it comes down to basically having a setup.

Have you ever seen when you go to a bowling alley and they put those big balloons in the bowling gutters. So that when you roll a ball, it won’t go to the gutter and it just keeps bouncing off. It’s really hard not to hit the pins? I think that is kind of what you have to do.

Once you’ve decided, “This is the path I’m going to go down with this strategy” I think then you’ve got to setup those little balloon things in the gutter to make sure that you don’t go off the rails.

So, that means coming up with rules, that means writing down your results before and after having good records. That means having somebody else to talk to about your trading, all of that stuff. It can even be working on with your mindset and your beliefs is the next step for that. But really, the focus has to be on execution.

You need to move away from what did the markets do, that’s in the testing phase and how can I make money here. You’ve got to get away from that. Those questions are answered once you’ve decided that this strategy is something you want to employ and then it comes down to execution. I think, that’s the key. What do you think?

Darren: I think so. The difficult is the point you said about, you have to do something that you believe in. If it’s true that we’ve all come to trading with the wrong beliefs and I think most of us do. Naturally, our beliefs about what sort of the game is a wrong then you’re a disadvantage already.

Walter: Absolutely, yes.

Darren: And it’s very hard to start and say, “What I believe about this is wrong” because you believe it and that’s the difficult thing.  

Walter: And you are going to seek out evidence that supports your belief.

Darren: And it’s easy to find in the way that the markets move.

Walter: Yes, absolutely. So, that gets back to your point about the big data. You’ve got to have a lot of data. You just can’t sit down at Forex Tester pound out 25 trades and go, “Look, it works.”

It’s got to be repeatable. Ideally, I think it would work on multiple markets, not just one market. It seems to me, I don’t know if it’s true but to me, something that works on just one market or one time frame, it seems a little gimmicky or kind of lucky.

Darren: Yeah, definitely.

Walter: Yea. It should work on more markets and then you’ve got to have enough of them where you’ll go, “Okay look, I think there is something going on here” and then it’s all about, so you’ve convinced yourself, now it all comes down to what do I do for myself so that when it goes bad and it will go bad that I don’t quit. And that I don’t say, “Ah, this doesn’t work anymore”.

How do I make sure that I don’t do that because that’s the big thing. If you go to these trading forums, everybody is talking about, “Look, this works”; “I need a system that works” or “This system works”.

Basically, there are two groups of traders on the forums. One is, “Hey, look at me. I’ve got a system that works” and the other group is, “Hey, I need a system that works”. Everyone is looking for something that works and then the problem is, once you’ve find that you quit because you’ve decided it doesn’t work anymore.

Usually, that’s is due to either a risk problem, risking too much when you get really confident. Or it’s simply, it does not much up to your beliefs. So, you’ve been looking for reasons to throw it away.

You were looking for something that worked rather than looking for something that made sense to you. Some traders wrote in this week and said basically like, “Hey man, convince me that price action works.”

And so my response is no and he talked about all these reasons why all these famous traders who’ve never use price action. So, I’m not going to convince him that price action works.

What I said was, “You don’t trade price action. You are talking about fundamentals, that is what you need to do. You need to marry your thoughts” — which was quite clear in his email. — His thoughts were that all of the really great traders used fundamental analysis to make money. So why would I send him down the wrong path? He needs to do that, right?    

Darren: Yeah, possibly. But, is trading about changing beliefs? Is the key being able to change your beliefs? Because, if we naturally come to trading with the wrong beliefs on some key elements, be in short-term, not sticking to a system, having to run systems over a long series of trades to really see the benefit. Is it really more about changing beliefs rather than to make it fit your beliefs, if we come to trading naturally with wrong beliefs?        

Walter: I hear what you’re saying. I think you are definitely right. Here’s what I think. I think that most people have sort of general beliefs about the market. It could be like you’ve got to understand the news in order to make money out of the markets, so it’s like a fundamental belief. You’ve got  to understand politics or economic policy or whatever to make money in the market.

So that’s one kind of core beliefs, the fundamental traders. Then there’s the other belief which is like, the trend is your friend. You need to trade trends and then the most common one or some people think the real trade setup when the market gets really quiet.

Markets really quiet right now. It’s getting ready to get really volatile so I want to be in on that, so they are the breakout traders. Or, there’s a trader that say, “Look, this has been going up too far, too fast, too long. I’m going to get in when it all collapses and I want  to make a pile of money quickly because I’m going to get in on the turning point.” the swing traders, the counter-trend traders which is probably the most common style of trading.

If you’ll look at the numbers, most people are trying to do that. So, you need to determine where you are in one of those buckets but then what you’re talking about, my belief is that, my belief about what you said is that, that comes down to kind of the fine tuning like you say.

First of all, if we’ll just scroll back on the chart and say, “This is what I would do.” That’s all hindsight bias, that’s total crap. That is not going to help and the other thing is, we know that we take profits too quickly. We all know that, don’t we? I know that the average trader takes, I did.

When I first start trading, I took profits way too quickly and we all know that most traders want to win more often than they lose. The easiest way to do that is to take profits too quickly. I think those are the core beliefs that the majority of us hold that we have to beat out of us over time.        

Darren: It’s like you can have an array of beliefs that are profitable but other beliefs are essential to get right.   

Walter: Yes.

Darren: Like you say, if you’ve got a leaning towards being more fundamental, you can make that work if your other beliefs are correct. Likewise, if you’ve got a leaning towards to being very technical, you can make that work. I think the key is knowing which elements are really important and which elements are really down to our personality choice.  

Walter: I’m totally with you on that one. Hey Darren, thanks so much for your time today. I really appreciate it and we’ll catch you in the next episode.  

Darren: Thanks, Walter. I will see you next week.

Walter: Okay, bye.

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