EP23: Confidence

The danger in thinking you are the shizz-nit is clear, and Darren outlines it in the form of the Dunning-Kruger effect.

We also step into the one dangerous idea perpetually losing traders have about everyone else.

Why banks are happy lemon juice is not a potent “invisible juice.”

What the fundamental attribution error has to do with trading for profits.

How to get on track if you don’t realize your shortcomings, and…

What little kids and yoga teachers can help you with, when it comes to your trading.

Download (Duration: 22:50 / 26.1 MB)

In this episode:
00:56 – Dunning-Kruger effect
03:43 – estimate your intelligence
05:40 – a dangerous line of thinking
09:24 – lemon juice example
12:43 – meta-cognition
16:26 – which element of trade are we talking about?
18:34 – meditation
20:14 – do you want to be a competent trader?
21:50 – sabbatical

Tweetables:
If you believe that you’re brilliant, it may be evidence you are certainly not. [Click To Tweet].
The more time you spend away from charts, the better your trading gets. [Click To Tweet].
To be a competent trader, take care of your mind first. [Click To Tweet].

Download The Full Episode 23 Transcript Here

Darren: If you have a bad method and you trade inconsistently, even if you believe you’re doing brilliantly, then you are going to keep blowing up your account.

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 Podcast. I’m Walter Peters. I’ve got Darren on the line. Hey there Darren.

Darren: Evening, Walter.

Walter: Today, Darren, you’ve come up with a beauty and I’m very excited to jump into this one. This is the Dunning–Kruger effect. For those that are unaware of what this term is, please explain to our audience what the Dunning–Kruger effect is so we can dig into how this possibly relates to our trading.

Darren: This is a new one on me. I keep finding out these knew cognitive biases, they’re called. They’re pretty scary as well as enlightening. Basically Dunning and Kruger were two professors at Cornell University. They wrote a paper called Unskilled and Unaware of It. They discovered that there was this gap between people’s self-assessed competence and their real abilities. They argued that incompetent people suffer form two consequences. One of them is that their incompetence leads them to make really bad decisions. The more important one is that they don’t have the ability to realize that their making these poor choices. Instead they blame their failings on outside factors, not on themselves. No matter how bad they do, they always think that they’re really good, really skilled and they’re doing really well, so they never actually improve.

The flip side of this, they found that the people that were really skilled and competent, they thought that everyone else must have these skills and abilities too. They thought they weren’t as good as they were and devalued their own abilities, and were then a little less competent, and they weren’t as go-get it as they should be because they were really competent, skilled people.

They got a load of students in to test this. What they found was that the most incompetent got their self-assessment massively wrong and the most competent devalued their own abilities by the largest amount. We all suffer from one side of this or the other. It’s quite terrible to find this out when we know that as traders we have to assess our own performance all the time, especially as retail traders, where most of us sat at home, we’re trading, and we have to make some sort of assessment about how good we’re doing and whether we’re able, “Can I give up my job to do this for a living?” You have to make those decisions on your own. What they found was that the skills to be competent are the same as the skills to assess that competence. Essentially, even if you think you’re really good, you might actually be the worst out there. It’s a pretty scary thing for a trader to find this out. What are your thoughts on that?

Walter: It sure is. It reminds me of two related, but slightly different things I learned in psychology. One was where we would take a class and we would say, “Estimate your intelligence. Estimate all these things,” and they’d give everyone the test and of course they say, “There’s a hundred and fifty people in this room, here’s what it’s going to look like in terms of your intelligence,” or whatever. We’ll just use intelligence. We know that there’s going to be some sort of a normal curve here, and yet when you actually tabulate the results everyone was above average. Everyone considered themselves above average. That’s a different thing to what you’re talking about because you’re saying that they actually separated the incompetent for the competent, or very competent, and they found different ratings based on whether they were incompetent or competent.

To me, what makes sense … That sort of makes sense because you would think that somebody who, and we’re talked about this before in a different podcast where, those individuals who feel like they need to work on themselves, they’ve always got something to work on, those people tend to do better than the people who think that they’ve got it all figured out. We’ve talked about that before, haven’t we?

Darren: Yeah, indeed. That is key. It’s that, can you take in information that’s different to what you believe to be right and can you accept new ideas, or are you always right? Are you always stuck in the mindset that everyone else is wrong and only your ideas are right, only your trading strategy’s right? If you are, then you’re probably leaning to the more incompetent side. The people who are very skilled, like you say, can take on those ideas.

Walter: Yeah, and they’re constantly working on themselves and working at it. This is one thing that I learned about four years ago, which was you get that idea in your head where someone tells you something or maybe you’re learning from a teacher, or a book, or whatever it is, in some sort of situation where you’re learning, and then you hear that voice in your head, “Well, I knew that,” or “Anyone knew that,” or “That’s easy to know.” I’ve learned to try and stamp that out as best I can because I believe that’s a really dangerous line of thinking, which is whenever you hear something you say, “Well I knew that. Oh yeah, of course,” or you discount that information that’s being presented and cheapen it. I really do think that’s a dangerous way of thinking.

The other thing that this reminds me of in psychology is, I used to work as a jury consultant, as some of you know, which is a profession that only exists in the United States because of the legal system, the way it’s set up. What we would do is we would help our clients who were in bad situations, usually you’re talking about big companies like insurance companies. We would help them when someone was going to sue them for a lot of money. We’d try and figure out, how are you going to set up your argument? What kind of juror do you want to kick off the jury? In the United States you can say, “Okay, this person has got to go. We can’t have them on the jury because they’re biased for this reason.”

My mentor, and the owner of the company, he has been doing this for decades. I think he actually really liked me. He started giving me his ties and things like that. He actually used one theory in psychology, one. He used that his whole career. He even told me this. He said, “Look, see how far you can go with one idea in psychology?”

He used to teach psychology at a university, but his entire jury consulting career was based on the fundamental attribution error, which is this idea that, let’s say I don’t know you Darren and someone’s talking about how, “Oh, Darren always does this when he’s drinking.” I might say, “Darren sounds like an alcoholic.” I’m going to blame your behavior on yourself. It’s a characteristic of you, that’s why you do that behavior. When it comes to me, when I do the exact same behavior, me or it could extend to someone who’s close to me like a wife or a close friend, a family member. You would say, “I didn’t do that because I’m a jerk, I did that because I was drunk at the time.” It’s the situation. When it comes to you the reason why you do things poorly or you’re incompetent, it’s the situation, and yet, when someone else does it it’s because of something internally.

That’s the fundamental attribution error. You can relate that to jury members. For traders it’s the same thing here that’s going on which is these people who are really, really competent, they are trying to figure out what’s going on and they’re not really sure if the people around them are as good as they are. Maybe the people around them are better. Whereas someone who is really, really low on the totem pole believes that they’re great. The example that we have here, did you see the lemon juice example, Darren?

Darren: I did see the lemon juice example, yeah.

Walter: Explain that on me because I think that’s a great example of the effect.

Darren: There was a bank robber and he’d read somewhere that if you put lemon juice on your face, then CCTV wouldn’t pick you up, CCTV cameras wouldn’t work.

Yeah he just put lemon juice, and then robbed a bank and thought he was going to get away with it.

Walter: Lemon juice is used for invisible ink, so of course, if I put lemon juice on my face they won’t see. These things are crazy. This shows you exactly what’s possible. If I’m a trader and I think, “Okay, I’m going to be really, really good at picking tops and bottoms. That’s my thing.” You can think of some of the things that might be an outgrowth of this, maybe that means, “Because I’m such a competent trader and I can pick the tops and pick the bottoms, I might as well really load up on this position. Why take a normal, two percent risk when I know I’m going to be right. I’ll go ahead and slap twenty-five percent on my account on this trade.” You can see where that can really fall apart.

Darren: Yeah, definitely. I read some more examples where this Dunning–Kruger effect can be advantageous. Sometimes incompetent people get into really powerful positions because they believe so strongly that they’re excellent at everything they do and all their ideas are brilliant, that people get sucked into it. Before you know it you end up with a complete lunatic who’s president of the United States. God forbid. That’s never happened. In trading I don’t think that’s the case because if you have a bad method and you trade inconsistently, even if you believe you’re doing brilliantly, you are going to keep blowing up your account. You do need to be aware of this. If you go back to the trading basics which are that you should keep a journal of your results, then even if you believe that you’re a brilliant traders, and you’re so smart and intelligent, that that’s going see you through, there should paper record sitting there in front of you that’s saying, “Hang on mate, maybe you need to get some outside advice there.”

In their testing they found that even if you were incompetent, that this could be changed with good training. First off you need to get to the point where you at least accept that you’re suffering from this condition. That’s the paradox of it is when you’re suffering from it the worst, when you are the most incompetent, you believe you’re the most skilled. It’s a trap.

Walter: That’s interesting. What I did when I did my PhD in psychology, I did a study where we were teaching little kids to think about if they understood a question. I know this is going to really boring for lot of people, basically what I spent a lot of my time in school doing was trying to come up with program to teach little kids meta-cognition. Meta-cognition, which is what the Dunning–Kruger effect taps into, which is a meta-cognitive skill which is thinking about your thinking. What we were teaching little kids was this ability to recognize when you don’t understand a question. The reason why that’s so critical in the legal setting is because lawyers are famous for using questions that are, shall we say, difficult to comprehend. In fact, they’ve categorized them and all that. We used the different lawyer categories of questions called lawyerese.

What we did was we were able, and a lot of people thought that this was not going to be possible, were able to teach even little kids this ability to say, “Hang on, stop. I don’t understand that question.” As we talked about in the last podcast, kids are really good at taking a stab at things. They’re just okay with being wrong because if they’re wrong with one answer then they’re just go ahead and blurt out another. This is really dangerous in a legal setting where you really should be thinking about whether or not you understand the question, this goes for adults as well, if you don’t precisely understand what the lawyer’s asking you, for example when you’re on the stand, you can give testimony that isn’t quite what you want to say, and is more along the lines of what the opposing attorney wants you to say.

You can see the application here, but what I found fascinating was it was possible to teach even little kids this ability to stop and consider whether or not you are confused, whether or not you understand what’s going on. I think what you’re talking about, Darren, is probably the process that I would recommend, something where you would say, “All right,” there’s two ways you can do it, you could have someone else, like another pair of eyes, look at your results and look at your trades and see what’s going on and actually tell you, which is probably the best thing. The other way to do it is to have something black and white and you plug in your trades, say, into a spreadsheet and they would pop out numbers. Someone who’s really analytical and quantitative would do this, you’d have pop out numbers and say, “Okay, this is what this says about you. This is telling me that you’re having more losers than winners and your losers are about the same size as your winners, so you’re losing here. You need to change something. Something is going wrong here.”

That would be one way that you could try and dig this out if it were happening. The other way is to just step back and ask yourself, “Do I feel like I’m superior to the others around me when it comes to the trading environment?” If that’s the case, I know everyone’s listening now saying, “No, no, not me. I’m not. I’m very incompetent.” We should’ve asked that question earlier on and said, “What do you think in general? Are you better than most traders? Are you about the same or are you worse than most traders when it comes to your trading skill?”

Darren: Yeah. When you start thinking deeper about it you think, which element of trade are we talking about? Are we talking about coming up with good strategies? Are we talking about actually sitting at the charts, pressing the button? Are we talking about all of the keeping data and that element of it? Personally, I’m probably competent in certain areas and incompetent in others. Who knows? I’m self-assessing myself, I could be way out.

Walter: Right. Exactly.

Darren: It’s a difficult one to do. The important thing, as with all of these stuff going on in your head, it’s about being aware of them and being aware how important they are, and don’t just blindly plow on believing that you’re brilliant, or even plow on thinking that your not any good. I always come back to this thing, you have to do some bookkeeping. You have to, it’s like any good business. You can throw the doors open and be busy in your hotel, restaurant, car workshop, but at the end of the day if you’re not doing the paperwork and you’re spending more than you’re taking in, you might just be busy fools. With my it always comes back to, what I’m probably incompetent at, and that is probably why I fix on it, is this idea of bookkeeping and record keeping and putting down stuff on paper so you can then make that assessment rationally rather than in the moment assessing where to exit or when to pull the trigger. All that decision making should be done outside of that, in a moment of calm, rational thinking.

Walter: Yeah, I think some of that could be done by putting yourself in the right mindset. You could do some meditation or you could just sit quietly for a while to get to that mindset before you do that. Does that make sense?

Darren: Yeah, definitely. I’m going on holiday in a couple of weeks time, and I’m taking your advice. The hotel I’m staying at, got a yoga teacher. I’m going to try and start doing a bit of yoga. Yeah, you’ve got to be open minded about looking at yourself and you as the trader, and not just your strategy.

Walter: That makes sense. Exactly. There’s so much focus, your body can conform to your seat at your desk and you can grow a beard if you’re sitting there focusing so much on your trading system. You’re sitting there hours on end back testing and Forex Tester. Meanwhile, the actual trading machine, you, is deteriorating physically and mentally because all you’re doing is bleary-eyed staring at the computer. Your body’s starting to conform to that seat. I think we’ve all been in that situation where you feel like, “What am I doing here? I spend so much time working at this.” What I’ve found is that the more time I spend away from the charts, the better my trading gets, perhaps partially because it’s daily and weekly charts. It’s also that idea of getting away, refreshing the batteries, taking care of yourself. These sorts of things are really important.

If you want to be a competent trader you’ve got to take care of your mind, your brain, your body. You’ve got to do something to refresh yourself so that you’re not in front of the computer all day. Then you come back to the charts with a really good mindset. One of the things I’ve learned from going through draw downs is that having that break, and then when you come back to the charts it’s almost like they’ve been reset. If you go away from the charts long enough, it’s almost like the charts have been reset and now you have this wonderful opportunity in front of you that’s completely different to the last opportunities that you had on the charts. It’s a really good way to reset and get going again.

Okay, Darren. We’ve summed it up here. We’ve said, as far as the Dunning-Kruger, there’s a couple of things you could do. You can take really good records of your trades and of your results. You could pipe those into a spreadsheet and get some objective numbers. What I’d like to do in the next podcast is look at a specific number that I think is a really good one for telling you, it’s a simple one to calculate, anyone can do it, and it’s a really good one for telling you how is your trading going. Maybe we can talk about that in the next episode. Keeping a good journal and writing down what you’re doing, why your doing it. What else, Darren? Is there anything else? We can mediate or just be really quiet before we sit down and objectively look at our records. What else can we do?

Darren: The idea of a sabbatical is a good one. That’s probably something for a future podcast, actually, because I’ve got some really good examples of that, where taking breaks really helps creative people. With the Dunning-Kruger thing, just do a little bit of self-examination. See if you’re the sort of person that thinks you’re always right and you always want to win an argument, and you think that your system is somehow got some market edge that other system don’t have. If you find yourself thinking that way then you’re probably suffering from overvaluing your own abilities.

Walter: Absolutely, that’s great advice. Thanks Darren. We will see you in the next podcast.

Darren: Cheers, Walter.

EP11: A Simple Way To Profits

Most traders are adept at looking at the charts through technical tools, but do you ever do technical analysis on yourself? Are there cultural differences amongst traders when it comes to what is important? What if you simply tossed a coin to determine your trades? Would that work? Darren and Walter each offer a very simple trading system to encourage you to “break away” from complicated strategies, and move toward simple trading.

Download (Duration: 35:50  / 41 MB)

In this episode:
03:00 – trade your time for money?
03:48 – in a rush
07:20 – traders who don’t know how much risk they take
11:45 – cultural background
13:25 – Tom DeMark
15:26 – the basis of most of my trading is buy low and sell high
18:13 – we have to have something to believe in
19:52 – what you’re using doesn’t really matter…..
21:28 – money management
23:36 – a different approach
25:39 – breaks
29:30 – the key

Tweetables:

Few people are content to accept that blind chance plays a large part in their lives. [Click To Tweet].
If price is high and it starts selling off, then what more reason do you need then to take a risk on a trade? [Click To Tweet].
When you first start trading, it’s kind of like playing roulette. [Click To Tweet].

Download The Full Episode 11 Transcript Here

Walter: What you’re using doesn’t really matter, but you’ve got to use something to keep you disciplined.

Announcer: Two traders, Darren and Walter, pull back the curtain on profitable trading systems, consistent money management, and profitable psychological triggers. Welcome, to the 2Traders Podcast.

Walter: In this episode of the 2 Traders podcast, Darren and Walter explore why “busy” traders may not be more profitable. We also look at the “trading trap”, otherwise known as weekly goal. You’ll see how to know when your emotions start to affect your trading. We explore behavioral analysis, the new paradigm in trading – and how one group is doing technical analysis on the trader, rather than the markets. You’ll see how the reward-to-risk ratio can create luck for you. And Darren and Walter create a one-sentence trading system – a very simple and powerful way to find, and exploit inefficiencies in the market. Should you use trading targets? Walter and Darren differ in their approach. Darren’s changing relationship with the weekend, as a trader. You’ll see how psychological pressures change as you advance as a trader. We explore where the giant leaps are made for traders, and it’s probably not where you think it is. And finally, we look at how trading presents your warts, and what this means for you, and your trading. All of this and more in this episode of the 2 Traders podcast.

Walter: Welcome back Darren. How are things in your world today?

Darren: Really good actually. I’ve had a really good couple of weeks. My trading’s good, I’m feeling positive. Yeah, it’s been going really well.

Walter: Excellent, excellent. Yeah, I’m feeling pretty good. Had a bit of a holiday, and I’m back now and sort of gearing up for an increase in the family size. We’re going to have another kid in the next week or two. Yeah, I’m feeling pretty good and kind of excited about just, I don’t know. It’s this feeling you get, because it’s springtime over here in Australia, and this feeling that you get where everyone’s sort of gearing up for Summer. They kind of know it’s around the corner, and people are starting to filter into the beach where I live.

The energy level’s kind of building, and there’s a lot of anticipation. I really like this time of year. Yeah, it’s been going really well. I was able to take a couple of trades while I was on holiday, and still kind of waiting to see how those unfold, because they’re weekly chart trades, so that’ll be a while. There are a couple of other ones that are setting up on the chart, so I’m feeling pretty good at the moment, yeah.  

Darren: Yeah, that’s the beauty with your longer term trading. Doesn’t take over your whole day, does it? I mean, you only need to give it a small part of your day.

Walter: Yeah, and I think you have to fight that feeling, because I think a lot of people, especially if they’re used to having a job, and when you’re at a job, it’s usually some sort of thing where they trade your time for money. Or, you’re trading some sort of end product like reporter or something for money. You feel like you need to be doing something. I think a lot of traders, when they make the leap into the full time trading, they probably over trade, because they feel like they should be doing something.

They sit down and think the charts, and they think, “Okay, what should I be doing right now? Where’s the trade?” I don’t really think, for me that’s not the best way to find the best trade. It’s almost easier to let it come to you, and just see, “Okay, wow, this looks so good. I’ve got to take this one.” Rather than, sitting down and trying to fish something out of the charts.

Darren: Yeah, I think that’s one of the hardest things that we, when we’re trading have to deal with. Everyone’s kind of in a rush. Not necessarily in a rush to make money, but in a rush just to be sure they’re doing the right thing. We kind of need that constant reassurance. It seems to be exaggerated massively in trading. We just need to know that we’re doing it right. We find it very easy, like you say, to just kind of be relaxed about it and let it come to you, and accept your sort of way of trading. It doesn’t necessary have to be perfect, doesn’t have to be the answer. People really want those kinds of specifics and guarantees, the way they’re doing it is right. That’s a really hard thing for people to get over. I have to work constantly.

Walter: Oh yeah, absolutely. I mean, I’ve had a few losers recently over the last couple months. It’s not a nice feeling but, the danger is that you fall back into that pattern of changing things up, and finding reasons to adjust your system or whatever. That’s the thing that I try and fight. This idea of being busy and doing something, you can put a lot of pressure on yourself. Especially when you say, “Okay, well I’ve got to make X percent per week, so that I can make the same amount of money I made at my job.” That’s why I think you should really have kind of a little savings that you can use for six, nine, twelve months to live on, so you don’t have that pressure to sit down and trade every day, and bang out some money. I just think it’s just not conducive to long term success.

Darren: No, you need to … I’ve been quite active with my trading recently. Do maybe about 20 trades a week, which doesn’t sound a lot, but I’m monitoring the charts from London, I can lay by Frankfurt open, and really up close to New York close. When you do that, you really got to be at the stage where you kind of trade methodically. I have all sorts of fears and worries and emotions throughout the day when I’m doing that, but I’ve just kind of, I’ve just learned enough to control it. The mistakes that I make don’t really affect my trading.

I’ve started to sort of keep data on my results a lot more than I ever used to. I put a post up the other day on one of the threads that I write for, and I had nine straight losers. I was just trying to sort of make an example of how my win rate … It was 100 trades … My win rate was exactly 50 percent, and I was just trying to sort of emphasize a point to people of, within that, there was like nine losers. Then there was like a run of really big wins. Then there was like a whole long period of winning and giving it back, and winning and giving it back before I had another nice little profit thing.

If you kind of look at the chart of your results there, you can kind of pinpoint these places where you’re going to be really affected by your emotions. That’s going to happen, and all the time you’ve got to know that that’s kind of coming round the corner, and teach yourself to deal with those things. It’s a really thing to learn. I think it just takes years and a lot of losing, and a lot of frustration before you finally say, “Okay, I’m making mistakes here.”  

Walter: Absolutely, and when you’re talking about plotting your own … I guess, sort of what you’re talking about reminds me of the … There’s a group in the states, and they have a team of traders that they employ, and they do analysis on the traders? The traders don’t know how much risk they’re taking on any give trade, so the way the platform is set up is they just enter their trade in there. Dynamically, the position size adjusts, and it adjusts based on what you’ve just spoken about. What they know is that, typically when the trader has a strong … When they do really well and they’ve got this great win streak that, they get a little bit overconfident and then they’re much more likely to start making poor decisions. These are obviously discretionary traders. What happens is, the system dynamically adjusts and reduces their risk, as they get to this point where they’re feeling really confident. It’s like technical analysis on the trader.

Darren: Yeah, it’s that kind of behavioral analyst.

Walter: Yeah, so they’ll do things like plot your moving average, and look for moving average crosses on your performance and things like that. The cool thing is, the traders are oblivious to it. They just enter the trade as if they would always. Of course they know when they’ve had some winners and losers, but they don’t know how much money they’re making or losing. The system adjusts, and likewise, the system will assume, as you’ve had a run of losers, it will start to actually increase your risk amount, because at a certain point, you’re expected to hit another streak of winners and so forth. It’s really kind of an interesting way.

I mean, some statisticians would disagree with this and say, “Well, that’s not really … Every single position, has the same probability of being a winner. It doesn’t matter, because they’re independent events, so the talk about this independence of events and stats.” Right? They’re more interested is … They’re almost plotting the psychology of the trader, and saying, “Well, you’re more prone to making mistakes when you’ve had a lot of winners, and you’re more prone to turning it around when you’ve had a streak of losers”, and so forth. Yeah, so they use the position sizing to capitalize on that, yeah.

Darren: Yeah, I think that the whole emotions and neuroscience and how we make decisions, is kind of taken over from the technical analysis thing, which was kind of the driving force for new ideas for a long time. It’s kind of being balanced out a little bit now, isn’t it?

Walter: Yeah, absolutely, but one thing I’ve noticed is … You’re right, I agree, I agree, but what’s interested is, you think about other markets. I had a friend who went over to China, and he was working with some traders in China … I have two friends, actually, that have done this … But now, what’s interesting in China is, it’s almost like in the western world the focus is almost shifted so much, as you say, from the system to the trader, right? This is happening, but what’s happening in China is it’s almost like they’re a few decades behind. One of my friends said that all the traders kept asking him the same question which is, “We need indicators. We need systems.”

These guys are really hungry for trading systems, because all their focus is on that. You might argue that, in some ways, the culture is better set up to produce traders that are a little bit more mentally strong or something like … I don’t know which side of the argument I would fall on that one, I’d have to think about it. Certainly, he came across with this notion that, it seems like they’re almost behind, because of the stock markets are opening up and trading is starting to be this big thing in China. It’s almost like they’re looking for the things that traders in the U.S. or in Europe were looking for two decades ago, where it was all about finding the right system, and the system is the key to unlocking your trading success.

Meanwhile here, we’ve sort of shifted and there’s a lot of focus now on the actual trader. I’m not saying that all western traders have decided to focus inward, and focus on the trader. Certainly, many beginning traders just focus on the system. I just thought that was really interesting. He said it was very obvious, the difference in focus over in China among the traders.   

Darren: I think that might have something to do with their cultural background as well, and their upbringing would have been very different to traders in the west. I think they kind of grew up in China where, certain things are kind of laid out for them in a very systematic way. Like, they’re expected to get married very young, and a husband’s expected to have a house and a car. Their cultural background from when they were a child is very different. That probably makes indicator trading very appealing to them. The thing is, indicator trading or not, it doesn’t really make any difference. It’s really if you believe in it, and you don’t mistakes, then that’s a bigger factor I think. I think we’ve just got to the point in the west now, where we don’t believe in them so much. Doubts creep in, and perhaps you make mistakes when we trade those sort of systems now.

Walter: I wonder sometimes how far it actually has come. In my world, because the traders I come into contact to are largely either just done with indicators, and they’ve decided they’re just not worth it anymore. Or, they’ve gone through all these indicators and they’ve burned through them, and they’re just ready to quit. “I don’t want to deal with these anymore.” Or, they’re just new to trading, and this idea of price action trading appeals to them. I wonder if it’s just the world that I live in, and that indicators are still very important to traders in other corners of the markets? I don’t know, and just the other day I saw … You know who Tom DeMark is, you’ve heard of Tom DeMark?

Darren: I do, yeah.

Walter: Yeah. They had him on Bloomberg or something, and he was talking about … I don’t typically watch Bloomberg a lot … But he was on Bloomberg or one of those, and he was talking about how the bottom hasn’t come yet, and we know that it’s this and that. He’s got all these proprietary indicators, and these funds that pay him for his indicators right? I mean, that’s his whole business, is based on selling very expensive indicators. I thought, “Wow, it’s just amazing to me that he’s still chugging along, and that people are still happy to …” It’s almost like they’re giving the burden to someone else, so that when things go wrong and the trades don’t go well, they can just blame someone else right? Blame the indicator or blame the service.

Darren: Possibly. Or, is it just the case of the technical element really isn’t that important. It’s your data, and also what the market does. I suppose really, if you manage your stop and your exit point right, then really, your point of entry doesn’t matter. Maybe they’ve just got the right data, that with those indicators you really need to go for a big risk reward, and it just so happens that the market is moving in that sort of fashion at that time as well, and it becomes successful. How much are they just being bloody lucky as well? All those things are a factor.

Walter: Absolutely. This brings me to an idea. What would you say, like if you were to come up with the simplest way to trade, and you can’t really use the random entry okay? Let’s just set the rules up. How would you set up an extremely simple, robust system to capture profits, without using the coin flip entry? Is there a way that you could distill a system down into a one line thing, and just use that?

Darren: The basis of most of my trading is buy low and sell high, okay? Then you obviously need some indication that you’ve picked the right low, so you wait for price action to close up with whatever timeframe you’re trading, okay? Then, we haven’t got the clout to move the market, so we want to see momentum as well. Then you use a breakout of that bar, and you just trade from low to high, and whether you support a resistance to be your low or high or pivots, or just the high and low of the period you’re trading. In other words, you do exactly what they tell you you shouldn’t do, you pick tops and bottoms.

Walter: Yeah, that’s awesome. Yeah, yeah, and it works.

Darren: Yeah, and then obviously, you need to make a decision, are you going to let all of these run and go for a big risk to reward? Or, are you going to manage it aggressively, and try and take as many winners as you can, and just have a small risk to reward?

Walter: Yeah, yeah, exactly. You need to decide which camp you’re in. I would do a very similar thing. What I would do, is I would say, “Look, you just need to find the cycle in the market, okay?” That might be as simple as putting the line chart on your chart, and looking at the weekly or monthly chart, right? What you want to see is, “Are we cycling up, or are we cycling down?” Then just wait for a big, giant candle to tell you, if we’re cycling up, and you see the market moving up, you just wait for that big, giant, red candle on the chart to tell you that you’re ready to start cycling down. Then put your sell order below that giant candle. It’s just as simple as that.

If someone came to me and said, “Look, I know all this stuff doesn’t matter. Just tell me a way that I can use …” I would say, “Pull up the monthly chart, put the line chart on. Wait for a big, red candle at the top, or big, green candle at the bottom, and just do that. Just trade off of that.” I don’t know, I’ve never tested it, but I’m going to now. I think this is something that, for those people who really want simple, it makes sense. It’s very similar I suppose, to what you just said, but I think it’s something that people can … They don’t need the Tom DeMark trend line.

Darren: I read an article in The Guardian about why we believe in religion and Gods and aliens, and all this stuff that’s not proven. Essentially, we have to have something to believe in. I’ve got a quote by the guy here. It was Louis Walpach. Have you heard of him, Louis Walpach?

Walter: No, no, no.

Darren: Anyway, he said, “Few people are content to accept that blind chance plays a large part in their lives. They seek reasons, even when these do not exist.” I think that so sums up what most people try and put into their trading, where it’s not really necessary. They want the reason why it’s going down. There needs to be some sort of story attached to that. Like, there is a trend line there or … What we do is we tell traders is, “We can’t time the markets. We haven’t got the clout that the big banks and the funds, and these …have got, so really, we need to sort of jump on their movements.” If price is high and it starts selling off, then what more reason do you need then to take a risk on a trade?

Walter: Yeah, yeah. Even the atheists believe in something. They believe in humanity, or the ability for humans to overcome problems or something. There’s going to be something there. In the ancient cultures, we have these ideas of story and story telling us why things are the way they are. These myths and legends and things like that. I think there’s a lot about humans that sort of crave this reasoning. It reminds me of the old random number tests that they do, where they give people a table of random numbers and they say, “What do you see here?”, and people come up with patterns in these random numbers.

That’s part of being human, but I suppose there isn’t really any reason to fight that, is there? I mean, if that’s the way that we think and the way that we interpret things in the world, information, there’s really no reason to fight that. I suppose that’s kind of why you’ve set up your trading system the way you have. You’ve essentially admitted that what you’re using doesn’t really matter, but you’ve got to use something to keep you disciplined. Is that fair enough?

Darren: Yeah, and use something that’s simple, and is not going to have second guessing. I see so many where, you’ve got to like, make judgments on five different things. At the meantime, your time is ticking. You need to decide if you’re placing this entry or not. Right at that moment, you’re having to deal with all of this data, and decide whether it’s right or not. Whereas if you simply that process, then you’re less likely to make mistakes. Then you’ll be regretting that you didn’t take the trade that wins, and then you’ll be questioning how you dealt with the data on the trades that lose. Whereas really, we can’t control those. We can’t really control those things.

Walter: Yeah, yeah. My trading partner and I, we used to trade the three minute charts, and we had a 17-point checklist that we’d have to check off before we took a trade. The problem with that of course, is by the time you had a signal and you went to the checklist, another candle had printed.

Darren: Yeah.

Walter: You’re in trouble aren’t you?

Darren: Yeah. I wanted to ask you something this week as well, about money management, okay? This is like a debate I’m having with some traders at that moment. The idea is, let’s say you trade intraday, so you trade through the week. This idea is sort of based on your data that you’ve got. You find a target for the week. Let’s say your target is 100 pips , okay? Then at any point in that week, if you hit your target, then you stop trading for the week. The idea being is that, based on your data you nearly always hit this target, okay?

Obviously, there’ll be some weeks that you hit it, and would have continued trading, and that would end up as a losing week. Then obviously, you just do that week in, week out. It’s obviously got to be a target that you consistently hit. Then you just slowly grow your account, and you compound your money, and that’s how you make your money. The opinion’s kind of split on this. I’m in favor of it. I think it’s a good idea, and obviously, your data needs to be good, but that goes for anything really. Yeah, I just interested in your opinion. What do you think about it?   

Walter: Yeah, that’s interesting. I think in theory it sounds good, but in practice it usually is difficult to implement. What you’re saying is that, the trader sets a focus essentially on returns, right? There’s a set percentage of returns that the trader’s looking for each week, and once you’ve achieved that it’s, “Okay, job well done. Let’s close her down for the week, and live to fight another week.” Right? Essentially?

Darren: Yeah, and going beyond that, when you’re trading intraday, it means that you have long breaks in between. You can still trade short time frames that require you to be at the charts, but if you hit your target Wednesday, then you have Thursday and Friday off. If you hit target Monday, then you have the rest of the week off. You work on being consistent instead.

Walter: Yeah, I suggest, for traders who trade like this, I suggest a different approach. What I suggest is, instead of setting the target based on percentage, return or pips or whatever, I think that you should have a set number of bullets in your gun. It’s kind of the same thing, but it’s not performance based. It’s actually trade based. What happens is, you hold onto these trades, because you have X number of trades per day, X number of trades per week. Once you shoot all your bullets, that’s it, you’re done for the week. What that means is, you might end up with the situation that you talked about, where you might actually achieve your goal on Wednesday, but you still have a few more bullets.

If you want to take them, if you’ve got a couple more bullets for Thursday and Friday, you might use those on Thursday and Friday if you want. Once you use them … And let’s say they’re both losers … You’re done. You can’t take any more for the week, and you’re off. If you have a whole bunch of trades that set up on Wednesday, maybe you take 90 percent of your trades … If your bullets are all locked in and loaded and you shoot them on Wednesday … Then that means that you’ve only got one more trade for the rest of the week, or something like that. What this enables you to do, it sounds like the assumption here is that you’re trading with profit targets, and you’re not using trailing exits. Is that fair to say?

Darren: I’m not really using trailing exits, no. It struck me that trading certain instruments, in a certain fashion, you’ll nearly always … Based on the data that I’ve received … I’d always kind of reach a certain profit target. I just wondered whether it would just kind of be a nice way to trade, because you get that break from trading. It takes some time to get used to the concept, but if you just put in consistently winning weeks, it’d feel great trading that way as well.

Walter: Yeah, I agree. I like the idea of the breaks. You can still get the breaks, if you have X number of bullets per week or per day. This is the problem I have with this, is that people, they’ll do a bunch of back testing, and they’ll say, “Okay, I can make 100 pips on average a week. So, after I get 100 pips, I’ll just quit.” The problem with that is, it’s like having a system where you have a profit target, because you cap your winners. What that means is, the average pips per week, has to be lower than 100 pips a week, because you’re going to have some weeks where you don’t do 100 pips, right?

What that means is, instead of averaging 100 pips a week … Which was your goal in the first place, because you knew based on your back testing that you could do that … You’re always going to have some outlying weeks that aren’t as good, and because you don’t have any outlying weeks that are better than 100 pips to balance that out, you end up with a lower than expected return per week. At least that’s what I’ve seen. I know it makes sense in theory, but to me, the focus is better placed if you just focus on the archer that has only so many arrows. If you can’t hit the target with this arrow, then you’ve got one more arrow.

You’re focusing so much on your arrows or your bullets, and not so much on the target, because that return … It’s true, that your average will be 100 pips per week, but you’ve got to make 100 pips every single week, right? You’ve got to spend 50 weeks a year hitting your 100 pips. If you can easily do that, then of course your average will be that. I think, typically what happens is we do have sub-par weeks, and when you cut that off at 100 pips, then what ends up happening is maybe you average 88 pips a week or something like that, which is fine. If you’re okay with that, that’s fine. If that’s really your goal.

You say, “Really what I want to do is average 88 pips a week, so I’ll have 100 pips as my goal, and I’ll cut myself off there. That allows me to have seven bad weeks a year or whatever.” Something like that. My approach is more about the number of bullets, rather than the performance base, but I understand why people do that, and I think you’re right. I think the real beauty in what you’re talking about is, it enables you to take that time off. Some people are going to kick and scream and not want to do that, but that’s going to really help you when you come to your charts again on Monday, Tuesday. After you’ve spent Thursday, Friday, Saturday, Sunday off. That’s going to really help, to come to those charts fresh, if you’re able to do that.  

Darren: Yeah. I think it obviously depends on how you trade. I used to dread the weekend, and be really excited about the start of the trading week. Now, I long for the weekend. Okay, just got to get through Friday, and then the markets are closed and I can switch off. I read a lot of Denise…. stuff, and she coaches a lot of really successful traders. The thing that strikes me is that, those psychological pressures of trading, they never really go away, you just learn better to deal with them.

It’s quite surprising when she recounts stories of traders coming to them, how so many people can be really, really successful for a long time, and just have a bad period, and it really affect them. My main sort of thought with this is, how can you … And with my trading strategy at the moment … How can you reduce those pressures as much as possible, and still trade consistently? I think that’s important.

Walter: I think you’ve nailed it. I mean, what you’ve just said here … For those people that missed it … This is really the key here, what you’re talking about. The reason why, when you first start trading that you can’t wait to get through the weekend and get to the beginning of the week, is because there really is some sort of mystery in what you’re doing. When you first start trading, it’s kind of like playing roulette. You never know what’s going to happen right?

Now, as you become more seasoned as a trader and you’ve seen a lot of things happen, you’ve gone through market cycles, in many different systems, what happens is, it gets kind of boring. It is kind of like work. It’s not as exciting as it was when you first started trading, and you read every trading book there was, and you couldn’t wait to quit your job. That sort of thing happens, but now you get to this state where, as you’re saying with the trading coaches, they realize this. They recognize that the real gains in trading are made when you, start managing yourself. Everything becomes about managing yourself, including your expectations, your limitations, your subliminal blocks. All of these things that are really determining what you do every day, including your trading. These become the focus, right?

The really special traders recognize that the gains are going to be made in removing the blocks, and creating more flow, and becoming more … How do you say it? … The best way to explain it is, I was talking to a trader once … And I didn’t realize it at the time … But he was in an absolute horrendous draw down, okay? Speaking to him, I had no clue, and I didn’t even know until later, that what he was going through was, essentially the worst draw down of his life, right? This was happening, but speaking to him, I wouldn’t have had any idea that that was the case. In fact, I would’ve thought that he was going quite well that month and that year, but he wasn’t. That’s kind of the goal, I guess, is to get to the point where you sort of let the numbers go.

As the casino let’s people come in and take money out, they know that, in the long run, they’re going to make money. You need to get to this point as a trader where you’re managing your emotions. You’re managing your expectations, and you’re really kind of setting up the psychological environment so that, your emotions work with your trading, rather than against it. My strong belief, is that every single trader out there will eventually … If they play the game long enough … They’ll get to that point, where this is the real focus of their trading. It’s almost like, it has nothing to do with your trading system, because it has everything to do with you, and how you implement your system.

I think that the coaches … Like you say, like Denise and those coaches out there that deal with traders … That’s really what their focus is on, it’s giving the traders tools and strategies, and ways of approaching this, so that they don’t get in the way of their own success, and they don’t block themselves from achieving what’s possible. That’s my approach, and that’s kind of how I try and think of this. Is, it’s really now less a gain about setting up the perfect system, and more about improving the way that I trade the system. It’s more about improving me and removing my blocks, and the things that are holding me back, and the things that are cyclical and destructive, and getting those removed, rather than focusing on improving the system. If that makes any sense.

Darren: Yeah. It’s kind of one of the hardest things to learn, isn’t it? I don’t think there’s any way of accelerating that learning really, other than actually sort of going through it yourself. I think you can read all of the books and take the courses, but that sort of element really, I think takes time. I’m always trying to think of ways of making that point concisely to people, who are starting out in trading if they ask me advice. I just try and make it really clear to them, but it’s a difficult thing to teach, and it’s difficult to learn as well. I think it takes a lot of time.

Walter: Yeah, absolutely, and self-reflection, and you have to be able to dig things out that aren’t very nice. It really is kind of like figuring out your faults, and determining where you fall short. That’s what trading eventually present you with. It will present you your difficulties, and your shortcomings. That’s why I always chuckle when people say to me, they say, “Oh, so you did a PhD in psychology, but you’re not using that anymore.”, or, “You got into this trading thing.” That’s always a little bit funny to me. It just shows you that people who don’t understand trading, don’t really get what it’s all about. It’s really all about the market presenting you with these ugly warts that are part of you, and you have to decide what you’re going to do about that. You get to decide now, “What am I going to do.”

Darren: I think before I started trading I was pretty much perfect, and now I realize how wrong I was.

Walter: Yep, isn’t that the truth? Yeah. Is there anything else you want to add to this? I think that we’ve kind of come full circle here, back into, really what it comes down to is it’s really about you and not the system.

Darren: Yeah, I think we’ve covered it today Walter. It’s good to have you back, and I want to talk about priming next week. I don’t know if you’ve heard of priming and …

Walter: Sounds good.

Darren: Yeah, and hopefully I’ll have another good week traded.

Walter: All right, excellent Darren. We’ll see you next week.

Darren: Okay, cheers Walter. Bye.

 

EP10: Random Entry Systems?

What does a guy who’s only had one girlfriend have to do with taking profits? Why do Darren and Walter test random entry trading systems? And what does the old lady on the airplane with the St. Christopher medal have to do with technical indicators and the illusion of control? Find out in this episode of the 2 traders podcast. You’ll also see how Darren uses a very simple discretionary system to outwit the trading algorithms. Walter explains how the risk of ruin is exponentially increased when traders make one simple (common) mistake.

Download (Duration: 30:22  / 34.7 MB)

In this episode:
01:40 – holiday time
03:57 – random trading = lotsa money
05:02 – support and resistance
06:03 – Saint Christopher Medal
07:30 – Scott Barlow interview in the book Every-day Traders
10:15 –  the odds and the probabilities over time
10:52 – an indicator that doesn’t do anything
12:58 – a guy who’s never had a girlfriend
14:08 – a simple trendline break strategy
16:30 – targets…..
18:18 – a time stop
21:15 –  taking profits too early
24:30 – technical elements really don’t matter
26:55 – why the system doesn’t work
28:02 – a very simple human-determined strategy

Tweetables:
Taking Profits too early is a bad habit. [Click To Tweet].
As humans, we are not setup to trade for profits. [Click To Tweet].
Taking profits too early is like marrying your first (and only) girlfriend. [Click To Tweet].

Download The Full Episode 10 Transcript Here

Walter: When you start taking profits early, you are literally increasing the odds that you will fail as a trader and People just don’t get that…..

Announcer: 2 Traders, Darren and Walter pull back the curtain on profitable trading systems, consistent money management, and profitable psychological triggers.

Welcome to the 2 Traders Podcast.

Walter: Hey there. Walter here from the 2 Traders Podcast. Today Darren and I take a look at taking a break. What does holiday time do for your trading? We also look at why Darren uses technical training tools, even though he believes they provide no edge for his trading. We also examine the random walk trading method and the surprising results that this style of trading will probably yield. A critical look at the Saint Christopher Medal, and what that has to do with trading. We also look at my favorite trader interview, and it’s not in the Market Wizards trading book. Darren floats his theory about the opposite signal test that he uses before he ever examines a trading system in seriousness. I’ve got a theory about the first girlfriend and trading exits, and we tackle this in today’s session. Darren and I also look at why you need to decide which trading camp you are in, and why this is so critical to your trading. You will see why I split my exits with my trading setups. We also jump into the haunted mansion, and the timed stop. Finally, Darren and I go into the most common trading mistake that kills many traders’ chances of making consistent profits. All this and more in today’s episode.

Welcome back, Darren. You’ve had a refreshing holiday, I understand?

Darren: Yeah. It’s been a really good break and nearly a month off trading. Like we were chatting before, it’s been really good to have that complete break from trading. Like I said, I’ve been thinking about it whilst I’ve been away. Whenever I come back, I always kind of have a little bit of an adjustment with what I was doing before as well. I kind of feel like I’ve got some sort of fresh ideas. It’s not new strategies as such, but just sort of a fresher way of thinking about my trading. That’s been really good.

Walter: It’s not a mechanical thing. Is it more of a psychological thing, or how is your approach evolving?

Darren: I’ve always got this slight inner turmoil with my trading, because I use technical things like support, and resistance, and price action, but at the same time, I don’t believe they offer any edge to my trading. It’s just kind of … I’m forever sort of trying to resolve that in my head and trying to sort of condense trading trying to sort of a one line idea, and make it really almost like … It’s like an eloquent equation that’s this really simple, and this is the process, if you like. I always have trouble with that, and it’s kind of become a bit clearer for me having that break. It always does when I have a break.

Walter: Here is something that I’ve thought a lot and I’ve tested it, this idea of the sort of the random walk trading account. Let me ask you this. If you had an account where you just flipped a coin or any sort of roll a die, any sort of random thing to get into a trade, decide whether to buy or sell, and you set up your exits so that it was 5:1, 6:1, 7:1. You are risking 100 pips to make 700 pips, for example. Do you think that you would make money on that trading account?

Darren: Yeah, I’d make a lot of money.

Walter: I think you’re right.

Darren: I’ve seen data that agrees with that notion as well.

Walter: This is one thing that I’ve helped traders who are kind of getting through blocks to see is that you should be focusing on your exit. You should be focusing on more than that, your exit, in relation to your stop. I know you are a big proponent of having these huge wide stops. I guess some people would say the same about me, really. I guess one of the things that you learn when you do this exercise, whether it’s on a demo account, or even just a small account, just to test it out for yourself, is you learn that it’s humming and highing over the reason why they get into a trade. Trying to refine that process is like almost energy pissed down the drain. It’s not worth it.

Darren: I think it’s the mindset you hold about those reasons as well. I use support and resistance in my trading, but if I don’t believe it, it doesn’t matter. It’s why do I use it. I use those technical elements to define a method. It means that I haven’t got that full going around in my head, why should this work? Why won’t it work? I know the method is there to stop me behaving badly, if you like. I wait for certain conditions to be met, that’s  a valid trade and I take the trade, but I know it’s not those conditions that are going to likely make the trade win. It’s not going to predict the outcome of my trade, but it just means that I can perform correctly. If I’m having a bad day, I won’t just go crazy and just ….. to random trade zone, because I have this kind of method I follow each day, and that kind of keeps me ordered. It’s for those reasons I use the technical elements.

Walter: Right. For some reason, I keep thinking of the old Catholic lady on the plane who has the Saint Christopher Medal, which to Saint Christopher, if you don’t know, is this patron saint of travelers, I believe. She feels really nervous getting on the plane and she’s taking off, but because she has this medal, it almost calms her down and makes her feel like she’s protected and that her travels are going to end well and everything is going to be safe. She is not running around the plane going crazy, because she’s got the Saint Christopher Medal. Is that a good analogy, or is that a bit off?

Darren: Yeah, because I’m sure … Maybe not in this instance, but generally if you think rationally about those things, you know it’s not really going to change the outcome of your flight on that plane, but it’s comforting as human beings to have something to believe in. That’s exactly what I do with my trading. I use these technical elements, and I believe the method is good, but at the same time, I know those on their own are not enough. It’s other elements that are going to decide whether I’m profitable or not.

Walter: Yeah, exactly. Let me ask you this, because this is one of the … I think I mention this interview all the time. I think this guy is brilliant. There was an interview of this guy in the book called “Every-day Traders” by Nick Radge, and this trader who … It’s actually on my bookshelf. I’ll pull it off. I forgot his name, but I’ll mention it here today. He outsourced his trading decisions, and his whole deal was just to manage the trade and go for a 3:1 reward to risk ratio. He would subscribe to this Forex … He was a Forex trader, and he would subscribe to this Forex signals. He ran a fund this way. All he would do with his fund is take the signals that the so-called-experts would rattle off and his job was to put it at 3:1. He said, “Look. I would only take a loss, or I would take a 300% win, and that’s all I ever do.” The reason why he did it was very specific. He thought that it was a good idea to outsource the reasons for his trading and not have that as his own burden. He didn’t have to feel like he had to tweak his trading system, because he had nothing to do with it. He was just implementing the signals that were given to him. I thought there was some brilliance there. I guess my question for you would be, given what you believe about the reasons why you take trades and the structure, would that work for you? Could you do something like that?

Darren: Yeah. He’s obviously kind of married to that idea of that’s how he’s going to decide his entries, but he knows that it’s really the fact that his winners are significantly bigger than his losers. That means that he makes profit. We are essentially doing the same thing. I look at those kind of concepts all the time. The one that strikes me or the one that I do is, when I look at a system, I think about if it works using say a certain signal is a buy, and I use say a 3:1 risk to reward, if that tests well and works, then in theory, it should work as well if I take the opposite position from the same signal but still use a 3:1 risk to reward. In other words, a signal that is normally a buy for me do sales at those positions, and then it should still work in theory. Does that sound totally crazy?

Walter: On the surface it does, but I believe that you are right, because you are talking about the long-term here. What you are talking about is the long game. Like if I set up two accounts, and one account would take a sell  and the other account take a buy, but at the exact time, they both had 3:1, for example, overall, both accounts will be profitable even if at that particular trade, one was profitable, of course, and the other one wasn’t. Is that what you mean or do you mean something different?

Darren: That’s exactly what I mean. The odds and the probabilities would play out over time. Obviously, the only element you can’t control in this is the movement of the market. If you have 3:1 1,000 pips, and the sort of yearly range is 900 pips, then it’s sort of unlikely to happen in that market. You need to consider the sort of the usual movements of the market within that, but that’s essentially what I’m saying.

Walter: It’s fascinating.

Darren: I did a post earlier on my thread on the forum. I just … A friend of mine has been working on a great strategy, and he had an indicator that just draws horizontal lines, and you just decide what space to put the gaps between the lines. I was just trying loads of different variations of size of gap. When you look at it, instantly cries out support and resistance to you, because no matter what size you make the gap, change the time-frame, these lines get respected. You can see why it’s so popular, because visually … It’s very enticing visually. You can just trade off these random lines and use random exits and make a profit. I just kind of try and get people to try and stop fixing so much on the particulars of entry and the particulars of price action. I think you can use those elements. I think we give them way too much emphasis.

Walter: I suppose the same could be said of indicators. You place all this importance on the indicators.

Darren: It really is the main problem that people are just basically closing their trades too early. They have a decent method, they are closing their trades too early, so they are not getting the correct risk to reward on their winners. Then obviously the inevitable happens, and they start losing money, and they change their method, and they get caught in the cycle, because their primary focus is on the entry, whereas all along , they are making the mistake themselves. I’ve even seen people sort of post back test results on my thread on the forum, where they give their results and the say something like, “I always close too early.” There is never any emphasis on that. There is never any, “Hang on a minute, actually is the problem here, me closing too early.” I think it’s because we’re just so … We are kind of like rabbits in the headlights. I think that that’s not an important element.

Walter: It’s like the guy who’s never had a girlfriend, and the first time he gets a girlfriend, he’s like, “Will you marry me?” It’s the same thing. You get these trades, and you have a lot of really poor trades that don’t work out for whatever reason. As soon as you get a nice one, you just want to make it count and cash out. I think this is part of the reason why where … As humans, we are not setup to trade for profits. We are just set up to lose, basically, and that’s just the way we are built. If you are an unusual human, then maybe you are set up to take profits, but that’s super rare. I know a trader in Canada, and he was telling me that he’s been trading this 4:1 system. He knows he’s got a 37% win rate, or whatever, so he just goes for $4 for every dollar of risk. He’s actually decided to move it. He’s done a lot of tests and he has decided to go down to 10:1. I think it was actually because I mentioned something that you mentioned in a previous podcast or something about the number that was best was 10:1 in the data or something? Someone was testing or something. What was that about?

Darren: That was someone … It was someone testing a simple trendline break strategy. I think 10 pips risk for 100 pips reward was way ,way more profitable than anything, but at the same time, 40 pips risk for 10 pips reward was also profitable. The extremes were profitable, and then when you got near the center, and you were sort of trading more on a sort of 1:1 risk to reward, then that’s where the amount of profit became very low, even losses were occurring. I’m always buying, and I want to buy this trade, the extremes, decide which camp you are going to sit in. Are you are going to go with a wide stop and have a high win rate or are you going to have a tight stop and a high risk to reward. I think making that decision to sit clearly in one camp or the other is really important, unless you can sit in both camps at one time and sometimes use a wide stop and then tighten it up. It’s just taking that focus away from the … Solely on the inventory , really.

Walter: Right, exactly. As traders, we move. We move away from that as you sort of aged and get experience. I think you get further and further away from the perfect entry, and you get more into, “Okay, let’s look at risk. Let’s look at, am I maximizing maximum favorable excursion  and all that sort of stuff.” We are just trying to figure out, “Okay, what’s going on here with these trades? How can I adjust what I’m doing even though I keep doing the same thing but in a slightly different way in terms of the exits so that I can milk more money out of this, milk more pips out of this?” That’s kind of a natural progression.

Darren: Tell me something about your thoughts on the exit, because I Know you … I might be wrong here, but from what I’ve seen, when you take your trades, you decide on a first  target, and a second target. Really, once these sort of trades kind of go in your way, are you trading to that target or letting it come all the way back to your entry, or are you taking notice of price action in between those targets?

Walter: Normally what will happen is I’ll have a first target and a second target, and sometimes I’ll have a third target. Typically, a typical trade will be entries triggered, which means it basically has to make a new high or new low. That’s just … I don’t know. The numbers of losers that occur because people want to get in on a retracement  to me is maddening, but that’s a whole other topic. Then what happens is, as it approaches target 1, ideally, it would blow through target 1. What I mean by that is that is if target 1is a support and resistance area … Say what you want about support and resistance areas, but we as humans, as you’ve touched on this today, we as humans can see patterns. They’re really, really simple and easy to see, and that’s why I love trading this… If it blows through that level, if it’s a resistance area and it closes clearly above it, or if it is a support area and it closes clearly below it, then I’ll move my stop to essentially break-even, and hope and pray that I hit target 2 and target 3. That’s the typical thing that I do. That’s basically … It’s simple as that.

Darren: Let’s say for instance, say your first target is at 3:1, and you get to 1:1 and you get something like a pin bar against you, or something … Some sort of negative-looking price action. Do you stick with the trade or do you … Would you ever just close your trade out because of the price action prior to hitting target 1?

Walter: The short answer is, it depends. Occasionally what will happen is I have like a time stop. I learned this from this guy who lived in a mansion in San Diego. I worked for him for a little while. He is a fascinating guy. He had all this mad interest. It was like walking into like a dusty old haunted house. He had stacks of papers and books and all these things. Anyway, he traded, but that was only thing that he did. He always had vast interests. What he taught me was, when you are trading and you take a trade, if you wait tool long, the reason why got in that trade is sort of like the market kind of forgets it. I do believe this about price action. I do believe that price action patterns are really, really good at highlighting what’s likely to occur in the near future, but they are not so good at what’s going to happen 20 candles  from now. My whole thing is, when I take a trade, I want momentum behind me. If I’m in a trade, and it just sits there for 10, 12 candles and literally goes nowhere, a lot of times I’ll just pull the plug and say, “Time stop. I’ve waited … Momentum was supposed to be behind me, and it’s not going anywhere, so pull it.” The other thing that I’ll do is if really close to may target 1, but doesn’t quite get it, I’ll also move to break-even. At that stage gets “Okay, this is house money now. Maybe I should have had a target somewhere else, but I’m not going to move my target. Just keep my target where it is.” If it comes back and tells me I break-even, it’s a trade that never happened in terms of the way I look at it. Those are two most common ways of getting out of a trade. I know you don’t do that, right? You just wait. It either stops you out or it hits your target.

Darren: I think some people perhaps as good at  reading price action, perhaps, or I think the fear is so much of losing what is already like in their mind winning trade. They perhaps, in the moment, ask, “That’s definitely a negatively looking bar. I’d better close.” They kind of then get stuck in basically anything at all  that is not price racing until they stop, they see as a negative thing and close. They kind of get trapped in that thing of actually never actually getting to target 1. That’s something that I definitely had difficulty with. I’ve tried to kind of evolve rules that although I might manage my position, it more likely may be a reduction in my stop, or at the most, move to break-even rather than close . I think for a lot of people, that can be an issue.

Walter: It is. I agree. You bring up two really good points. One is, if you are taking profits too early, that’s a bad habit to get into, because what that does is it shifts the probabilities that you are going to blow up your account. If you have really good numbers in terms of your win rate and your reward to risk ratio, you can get a handle on knowing what your risk or ruin is in terms of … This is all probably really theory. It’s statistics, and you can argue whether or not statistics are useful or viable, or whatever, but according to the numbers and what the statisticians will tell us, they’ll say, “You are 0.8% likely to blow up your account.” As you start taking profit too early and you shift your reward to risk ratio in the wrong direction, that less than 1% likelihood of blowing up your account, that might become 33%. It could literally shift that quickly that fast if you take profit too early. I think what you are bringing up here is a huge problem that a lot of people aren’t aware of, because they think of it in the same way. They think, “I’m taking 93 pips instead of 100 for this, but that is a dangerous habit to get into. As you do that and you whittle away your profitable trades, you reduce your reward to risk ratio, and you just inch closer to destruction. People don’t realize that. The other thing that I think you bring up is, people say, “I’m in this trade, and then I get a Kangaroo tail against me, so I better get out.” If you trade the way I do … I’m not saying it’s the best way. I’m just saying, the way I look at it is, the market shouldn’t … If I take a trade, then the market is so expanded and volatile and in a swing mode, that in theory, if a Kangaroo tail prints halfway between my entry and my target, that kangaroo tail is printing in no man’s land. There is no support and resistance there, and therefore, it should be ignored. It’s not important. The only Kangaroo tail that matters is one that prints at a level where the market has repeatedly remembered to reverse there. When people say, “Oh no! Oh no! There’s a kangaroo tail against us,” I say, “Who cares? There’s nothing behind it. It’s got no teeth, so just forget about it, and let the trade unfold.” If it ends up being a loser, fine, but the point is, getting into this mentality of taking quick profits, although it feels good, is dangerous. I think a lot of traders don’t understand the risk of ruin, and they don’t understand this concept of, when you start taking profits early, you are literally increasing the odds that you will fail as a trader. People just don’t get that. I think that those points you bring up are just spot on.

Darren: It pushes you then where you are sitting in either camp, because you are taking as small stop loss, which generally is going to give you a low win rate, and then you’ll not get enough risk to reward. You’ve sat on the fence, really, with your money management strategy. I think that’s a massive problem. It might even be one of the main reasons that people fail. Here’s something else. I’m saying that these technical elements really don’t matter, as long as you’ve got the risk to reward et cetera et cetera. Then I look at certain ideas, and they seem to work only on certain parts. That one really flamixes me, because I am a strong advocate of saying, “If it works on low time frame, then it should also work on a high time frame,” and so on and so forth. Then I’m kind of saying the patterns don’t really matter, and you can trade random patterns. Then I find patterns that seem to just work on one or two parts. What I’m trying to say is, take what I am saying on these element’s sort of pinch of salt , because there is always exclusions to the rules. As an example, there’s something I tried which is looking for the high and the low of the day. With you, you look for support and resistance to add teeth behind your entries, and I’m kind of looking to see if we are trading off one of the most extremes of the day, if we are turning around from a new high on the day or a new low on the day. This works superbly on the Euro/Dollar and the Pound/Dollar. What I’m doing now, I’m basically forgetting the Asian Range, and then I’m waiting for price to spike up to a new extreme and then turn around. I’m using that new level, that new price level and the reversal as the indication that there’s a support and resistance level there. I don’t even need to draw the line. I’m looking for the movement of price. I don’t want to call it price action, because I think it’s more than that. The actual candle shapes don’t matter to me. It works superbly on the Euro/Dollar and the Pound/Dollar, but on the Pound/Aussie or the Euro/Aussie and things like, it doesn’t work at all, and that’s because those patterns on the Euro/Dollar and the Pound/Dollar nearly always happen in London and New York Session. There are patterns that are significant to certain instruments as well. I think those are much harder to find, but may be more useful.

Walter: That’s fascinating. I guess essentially what you’re saying is in that case, the reason why the system doesn’t seem to work is because the market participants are not in this … It’s not traded at the same volume level. Maybe the Pound/Aussie is traded more often, or there is more significant volume in Asia than there is the Pound/Dollar or something like that.

Darren: Sure. That’s clearly what’s happening. When I first noticed that, it was just surprising to me, because in the past I would say, “No, if there is a pattern that exists on the Pound/Dollar, then it’s most likely going to appear on all level. It could pass as well.” It was quite a surprise to me to find that they were. I’ve recently seen more people do really detailed research on say like the difference between the stock market and the Forex market. There are patterns that are significant, but I think a lot of the time, we as traders focus on the  illusionary patterns.

Walter: What’s interesting to me is there is all this talk about the algorithms and how they are just ruining it for traders, and yet probably the number one pair that has more robots trading in, more algos are in the Euro/Dollar than any other pair in Forex. What you’ve just highlighted is a very simple human determined strategy that you use on this pair, and yet everyone else is throwing their hands up going, “The algos are running it for us. This is terrible. The end of days,” and so forth, and yet that pair seems to behave in a …As you can see, for your trading, it seems to behave in a really rationale way, and algos be damned. You are still able to see a very simple way for it to establish a range for you to trade in.

Darren: Definitely. Go and test it for yourself. Look at the Euro/Dollar and trade the turning points so that the current high and low all the day, and it’s very … I do a bit of hedging as well, but I’m not going to go into that on this podcast.

Walter: Sure. I think we don’t have time. We are running out of time here, but I wanted to just talk about a strategy that I learned from a guy who was interviewed to be in the Market Wizard … They wanted him to be in the Market Wizards book, but he refused. He didn’t want to have any of that, but it’s tangential to what you’ve talked about today. I’d like to leave that for another podcast, but I think because it’s fascinating to me and it’s something that’s almost like an overlooked thing about the day, and yet I’m sure some people look at it, but I just thought it  a really cool way to setup a trade for the day. Anyway, any final thoughts Darren? It’s good to have you back. I’m glad we are both feeling refreshed. I’m feeling refreshed because I’m about to take off on a holiday, and you are feeling fresh because you’ve come back from your holiday. I think this has been a good session overall.

Darren: Holidays are great, Walter. We spoke at length about that in our Sabbatical podcast, but great to see you again, mate.

Walter: All right. Have a good one, and good trading to you.

 

EP09: Moving Average Systems

What can you do with a moving average? How many strategies, methods or uses does a moving average hold for a forex trader? The answer is…plenty. In this episode, Darren and Walter lift the veil on the many uses for a moving average. You’ll see how many different ways (some of them very unconventional) you can use a moving average. Some you may have heard of, but others may be new to you. So if moving averages are in your trading arsenal, you may want to dive into this episode of the 2 Traders podcast.

Download (Duration: 16:33  / 18.9 MB)

In this episode:
02:02 – a pseudo-intelligence test
03:36 – moving average as a dynamic trend line
04:48 – using many moving averages….
05:57 – trend hints
06:48 – institutions using moving averages?
07:37 – moving average as a trailing stop
08:34 – market turning Points
09:41 – the bigger (price) picture
11:46 – the line chart is a moving average?
13:00 – the holistic view
13:55 – Darren’s “moving average myth”

Tweetables:
A simple trailing exit: get out when the moving average bends the other direction. [Click To Tweet].
When moving averages expand, the trend continues. [Click To Tweet].
Price is not attracted to moving averages – it’s an illusion. [Click To Tweet].

Download The Full Episode 9 Transcript Here

Walter:    If you like to use trailing stop and you’re the sort of person that wants to sort of shoot for the sort of runners and the bigger wins, then it’s a really good market. A lot of people tend to-

Announcer:    Two traders, Darren and Walter, pull back the curtain on profitable trading systems, consistent money management, and profitable psychological triggers. Welcome to the 2 Traders Podcast.

Walter:  In this episode of the two trader’s podcast, Darren and I looked at that Swiss Army knife tool that traders used, call them moving average. We looked at how you can use a moving average to both: find exit for your trades, find entries for your trades and even how to analyze the market. Darren argues that the moving average is actually more valuable than support resistance, and he’ll explain why. Darren also reveals why when price moves across a moving average, you should definitely pay attention. How you can even take the simplest of all moving averages and create your own trading system. And finally, we wrapped up today’s session when Darren dives deep into the problems that traders run into when they see illusory moving average relationships on the chart and how you can avoid these. All these and more in today’s episode of the two trader’s podcast.

 Walter:    Welcome back to the 2 Traders Podcast. Walter, I’ve got Darren on the line. Hey Darren.

Darren:    Hello Walter.

Walter:    Today Darren, we’re going to talk about the moving average. I’m reminded of this intelligence test or maybe a pseudo intelligence test where they give the subject a paper clip and they say, “Tell me all the different ways that you can use a paper clip.” The idea is … I think it’s actually more of a creativity test, but the idea is that the person who’s more creative can actually come up with many different ways to use a paper clip other than the obvious, right? My thinking was today we’re going to jump into the moving average. You thought it was a great idea. Today we’re going to talk about the moving average and all of the different ways that you might use a moving average in your trading. I’ll start off by saying I’ve got a list of them here. Maybe we can ping-pong back and forth, if that works for you. I’ll just do one. One way to use a moving average is that you can watch … and when I first learned this, I thought it was amazing. You can use the direction that the moving average is pointed as an exit system, as an exit strategy.

Let me give you an example. Let’s say you’re in a buy trade. You’ve got probably a really low moving average, like an 8 or something like that, moving average. You’re in a buy trade and you want to know when to get out. What you do is you wait until the 8 moving average actually turns down. It’ll be moving up of course for most of your trade if you’re in a strong uptrend. It might go flat and just stay horizontal, but as soon as the market closes and you actually see that 8 moving average dip down and actually angle downward, then you close the trade. That’s one use for a moving average. Can you give us one as well, Darren?

Darren:    Yeah, one of my favorites is using the moving average as a dynamic trend line. You know the sort of classic trend line entry. You wait for the trend line to break, and then you wait for price to pull back to the trend line. That’s where you look for your entry and essentially use a moving average the same way. Pick something around the middle. I like the 50 simple moving average, wait for price to break over the moving average and then pull back and then take your entry there. It’s just a simple trend line system. You can even use the break back over the trend line as an exit, although I’m not as keen on it as I am for an entry. Use it as a trend line, wait for price to break over, and then pull back towards it. It doesn’t have to touch it, just any pull back, and then use that for your entry.

Walter:    Cool, all right. I’ve got another one. In this way, I think this reminds me of a system that I used a long time ago. It was exciting for me because it was the first time I actually made money in the markets. What I did was I had a bunch of moving averages, but you can do this with just two. You might have a really low, like a 10 moving average and maybe a higher one like a 50. What you do is you just wait for them to both be pointed in the same direction. They could both be pointing up for example in an uptrend. Then you wait for the market to collapse, so what happens is the lower moving average moves toward the higher one, and then when it gets there, it bounces off of it.

You get in on a trade right on that bounce when the two moving averages sort of compress and come closer together. Then the lower moving average, the 10, or 8, or 6, or whatever it is, it sort of turns away from the 50 and you get in there. Because what you’ll see, of course, in most uptrends and many downtrends is you’ll see the market … these moving averages spread apart, get close together, spread apart, get close together. You can use that rhythm and time your entries based on that. That’s another unique way I believe and fun way to use moving averages to time your entries. Any other moving average thoughts, Darren?

Darren:    Yeah, another one very similar to that that I like where you use say like a 50 and a 30 or a 50 and a 20 moving average, and you look for, one, something that’s trending. You’ve got a nice slope in moving averages. Then you look for price to pull back into that pocket that the gap in between the moving averages. You look for your entry there. If you kind of prefer a more, a good value entry, and you like to get deep retrace entries, that’s a really good sort of value place to look to enter. You wait for a trend to develop, and then you look for a pull back into the gap between the fast and the slower moving average.

Walter:    That’s great. Here’s one that they say, I don’t know if this is true, but they talk about institutions using this really high moving average. Usually it’s like the 200 is what they say. They say, “Well, if the market’s above the 200, we know we’re in an uptrend. If it’s below it, we know we’re in a downtrend.” Now, of course, the market can jump around and stay up and down and up and down around the 200 as well, but the interesting thing about the 200 is it’s really slow to move up or down, so it kind of just sits there and it’s kind of like a zero point for a lot of traders where they see this as the line in the sand, and we know the market’s turned when it closes below the 200 or goes back above the 200. That’s another way to use a moving average. Do you have any other ones, Darren?

Darren:    Well, the final one that I know that somebody uses is it’s very good to trail your stop behind. If you like to use trailing stop and you’re the sort of person that wants to sort of shoot for the sort of runners and the bigger wins, then it’s a really good market. A lot of people tend to trail less stops behind the price. It’s not very good because that swing point you’re trailing behind is generally a key support and resistance level that people are watching and institutions like to push price through to collect the stops. Instead, use a moving average for your trailing stop. You’ll find that you keep in those long runners much, much longer.

Walter:    Excellent, excellent. There’s one more thing that I thought of. If you’re a trader who likes to find those turning points, so you’re always kind of looking for that reversal, that swing, that swing high, swing low, and you really want to hook into those, what you might do is you just wait for the moving average to turn around. It doesn’t have to cross or anything like that. You might use something else, like maybe you see it go to like a double top or a historical level that usually reverses that in your thinking. What you might do is wait for that moving average to turn around. If it’s going up, it just starts to bend and turn lower, then you get into the trade. What that means is that you’re going to get in a little bit later than some others might, but it’s also more like that it’s confirming … it’s got more movement, more closing prices are behind your direction. It’s a little bit safer for some people than trying to get in immediately and getting burned. That’s another way to use moving averages. What are your thoughts about the moving average? Are you using it right now in your trading?

Darren:    Yeah, I’ve kind of always used moving averages really. It’s a way of looking at the bigger picture of price. I really like them. Essentially, really, price if you put your line chart on instead of your candlesticks or your bar chart, then essentially that’s a one period moving average anyway. We’re kind of always … we’re kind of already using a moving average. It’s just kind of saying let’s have a look at the slightly bigger period. You know something I noticed once … it was quite fascinating was when a time frame crosses the moving average, you generally have reversal candle pattern on the higher time frame. If you find a spot on your chart where the H4 has crossed over the moving average, you’ll invariably see some sort of outside bar on the weekly chart, or some sort of reversal candlestick pattern on the weekly chart. That happens for all of the time frames. Essentially the moving average is just giving you a little look at the higher time frame as well, which is another way of looking at it really rather than just a line, you know?

Walter:    Yeah, that’s a great tip. There you go. You would see that happening on the lower time frame, and then you would … and then I suppose later on obviously you would look up to the higher time frame and see that sort of reversal set up. Is that right?

Darren:    Well yeah, it’s kind of like you were saying when say you see the H4 chart and there’s a double top. If you wait for it to cross the moving average as well, then it’s almost like a confirmation that the higher time frame has turned as well now. You get a hint from the price action on your time frame, and then when it crosses the moving average, that’s kind of like a second confirmation, and a really good way of timing entries like you said.

Walter:    Yeah, yeah. It’s excellent. I love the line chart, which is, as you say, it’s a one moving average on the close. That’s probably one of my favorite charts. I think that people listening to this … I challenge you to take a look at the line chart, which again, it’s the one moving average as you say. Come up with a system because I believe you can just by observing what happens on the line chart. I think that’s a great place to start for somebody who’s wanting to simplify their trading, but kind of still want to have that feeling like you’re relying on an indicator. You know, you don’t want to totally get out of it, so you are, in essence, looking at an indicator. It’s a one moving average on the close. That’s a great place to start if you want to set yourself up with a really simple system. Any final thoughts on moving averages?

Darren:    No I think that is it really. They’re a great tool. Like you were saying then, don’t be put off because it’s an indicator because it’s essentially a higher time frame price chart being shown on your lower time frame. It’s priced as well, and it can be really, if you use it simply, it can be a great tool I think.

Walter:    Yeah, it’s great. As you say, it’s sort of like a holistic view because you’re getting all of these candles are being put into the line that’s moving today. It’s not just looking at what’s happening today. Unless, of course, you’re looking at the line chart. But what you’re seeing though in that line is all of … like if you’re looking at the 20 moving average, right? All of these … the last 20 candles are all sort of part of this line. It’s really good for people who tend to focus in and forget about the big picture, and they don’t approach the markets holistically. If you have a moving average on there, you can’t avoid that because it’s obviously all that is going into the line. It’s a really good way to see recent activity in the market. It’s a great tool, great tool.

Darren:    Yeah, can I just make one final point, Walter?

Walter:    Of course, yeah.

Darren:    There is one thing that I don’t believe in. This is this idea that price is attracted to the moving average. That to me is complete tosh because we know that price moves the velocity of price changes. It’s just logic that it’s going to return to the moving average. I mean, if it never returned then that would be something worth talking about. I hate it when people say that the price is attracted to a moving average like a 100 or a 200. It’s just inevitable. To me that’s logic. The other one is that people say that price consolidates around a moving average. Again, that is just a complete optical illusion that’s going on in your head. If you get a marker and go past, go back … whatever’s on your screen, mark all the consolidations, and I bet you whatever you want, you’re going to have a lot more consolidations that are not at the moving average than you are at the moving average.

It’s just something about those two elements coming together, the price and the other line, basically, that this little optical illusion … your brain picks up on that. It discounts all the other information. Yeah, I see that a lot in trading where people kind of see stuff. They kind of blank out what they don’t want to see, and they kind of believe this tiny little bit of information. There are some fallacies about it as well. Think logically about what it’s really showing to you.

Walter:    Yeah, that’s great. You know what, Darren, I think maybe in our next episode we can dive into more of these optical illusions and fallacies because there are plenty of them out there. Does that sound good to you?

Darren:    Yeah, that’s great. I’d like to do one of those next time definitely.

Walter:    Yeah, next time let’s jump into that. I think that will be a really fun podcast. Until then, Darren, thanks so much for your time. I really appreciate it. We will see you in the next episode.

Darren:    Cheers, Walter. Goodbye.

Walter:    Bye.

EP08: Is Complex Trading Right For You?

Why does it seem to be that profitable trading is so difficult? Does this mean we must create complex methods for pulling profits from the markets? Are most humans designed to lose money in the markets? Why is this? And what can we do to change this propensity, if it is true for most of us. Darren and Walter look into complex trading systems in this episode, and come up with strategies for countering the (unprofitable) instincts traders employ when trying to improve trading systems.

Download (Duration: 34:22  / 47.2 MB)

In this episode:
01:40 – Books vs. Kindles
03:01 – crowbar vs. a powerdrill
03:25 – When trading systems “fail”
03:41 – why does difficult = complex?
05:01 – Walter’s USD/JPY neural network
07:03 – predicting the markets vs. making money
08:22 – Darren’s approach to robust system building
11:00 – the problem with nuclear reactors
13:05 – how Darren uncovers profitable system attributes
17:05 – the curious case of Scott Barlow
18:58 – the seduction of _____
19:44 – The weird reason for enjoying your losses
21:07 – Darren’s solution for simple profitable trading
22:00 – when fear dictates your stoploss strategy
25:24 – an unusually simple (and profitable) trading system
28:46 – your judgement calls define your success
29:14 – how Darren cooks sea bass
30:41 – beating yourself up is the wrong thing to do
31:01 – the magic of re-entry rules
32:03 – Walter’s tip for trading simplification
33:41 – what can you remove from your system?

Tweetables:
Books don’t break – but Kindles do… keep things simple. [Click To Tweet].
Enjoy your losses, you will learn more from them than your winners. [Click To Tweet].
Experience is the antidote for over-complicated trading systems. [Click To Tweet].

Download The Full Episode 8 Transcript Here

Darren: Essentially, it’s trying to simplify the whole process, really, rather than making the entry, the management, and the exit all …

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: All right, welcome back to the Two Traders podcast. It’s Walter and I’m here with Darren. Hi, Darren.

Darren: Hi, Walter.

Walter: Darren, you have this idea and I thought, “Brilliant.” It was sort of fortuitous because I had just read this book review by one of my favorite authors and then you had this idea about, diving deep into this topic, so would you like to explain to everyone listening exactly what’s on your mind?

Darren: Yeah, this is Nassim Taleb’s new book, “Antifragile,” I think it’s called. I saw him do a seminar on the internet about the book and basically part of the premise is this idea that we’re obsessed in the world now with making stuff more complex. We’ve kind of got this notion that if you make it more complex that we are basically improving it. He’s saying, “No, actually what you’re doing when you’re making things more prone to fail and you’re actually making them more fragile. He made a really good analogy about a Kindle and a book. I was, “Everyone wants a Kindle because we think they’re so much better than books,” but he said, “Well, you try destroying a book and you try destroying a Kindle and you see which one’s most fragile.” They both essentially do the same job, but we as human beings now, we just seem focused on this idea of the complex thing being better.

We have these Kindles and we think it’s great and we go on holiday and then you spill your drink on it and it’s broken. When have you ever broken a book? It’s nearly impossible.

Obviously, it was much more to this, but for me as a trader, I thought this was fascinating because now how many times have you seen people say, “Well, you know, the system failed today, perhaps we need to add another moving average, or we need to, you know, only take pin bars.” We complicate our systems and how we trade, thinking we’re making it better and in effect we could actually be making it much harder for ourselves. That’s what I thought that was one of the ideas in there that I thought was fascinating. What do you think?

Walter: I agree. I think this is great. It kind of goes along the lines of my thinking in terms of keeping things simple and you’re looking for … At least my opinion is, as a trader, you’re looking for really simple robust things that tend to work and you can use plenty of analogies. You know, you can do a lot of things with a crowbar. You can hammer a nail, you can open a door, you can lift something, you can crack something open, you can sort of use it as an ax, lots of things with a crowbar, but there are only a limited number of things that you can do with a power drill. Right?

Look, I’ve got a little bit experience in this area and I think that I fell into the same trap that a lot of traders do, which is, “Look, I’m trying to make this trading thing work and it’s not working, so obviously it’s very complex and difficult.” Right? In our mind we have this idea that if it’s difficult, it must also be complex, which I don’t necessarily agree with when it comes to trading. Right? I mean, what do you think?

Darren: Yeah, definitely. We generally look in the wrong place for the solution and we think that it’s the technical side because side is numbers and numbers is maths and maths is intelligent, so that’s going to be the answer. Whereas, generally, the answer is you need to just stick at your system and be a bit more consistent in how you trade and not make any snap decisions about what’s wrong. It’s obviously a natural urge for humans nowadays to look down that route. As we say we trading, the majority usually wrongs, saying your gut instinct is usually wrong and you need to, again, step in the way of your decision making. When you’re looking to improve your trading purely through the technical side, then you need to question whether you’re just complicating it because you feel that’s the right way to go.

Walter: Yeah, I definitely did. I’ve got a bit of a background in statistics, so what I decided when I was trading … This was actually after I already discovered some simple naked trading patterns which are essentially my bread and butter now. I decided that I wanted to see if I could build an algorithm, so I got deep into what’s called neural networks, which is basically a system that just loves data.

What I was trying to do, and I found this out over time, is you need to predict something kind of smooth with these systems. Right? Otherwise, it will get really choppy, so I built a neural network for the USD/JPY. What I found out was you weren’t supposed to try and predict where the dollar yen would be tomorrow in terms of a closing price or something like that. What you needed to do was predict the moving average.

To really make this work, you really need to predict two moving averages because you want to see the spread between them to see how fast it’s going or if it’s going to turn around and go up and down. What I did was I predicted the ten moving average and the twenty moving average of the USD/JPY. You can only imagine that I had tons and tons of data to put in, and these from the world markets, like Germany. Everything you could think of, I would dump in there, and some indicator data as well, just to top it off.

What I found was exactly what Taleb’s talking about here… it was interesting because it would work for a while. It was pretty good at predicting what the moving average would be two days in advance, but then there would be things that would come up and it wouldn’t make sense. Like something would happen where the twenty moving average was predicted to move faster and more violently than the ten moving average. Right?

Then I knew, “Okay, this isn’t going to work.” It was early days. The thing is I fell into the trap of thinking that this is something that’s difficult to do, so it must be complex, and if I really want to gain an edge here, what I need to do is build this artificial intelligence style neural network that’s going to predict the future for me. That sort of thing.

I really over-complicated it. I think you have done a really good job in terms of looking at charts and figuring out, “Okay, what do I need to do to take a bite out of the profit that’s available to me in this market?”

Which is a different way of approaching it than what I was doing back then, which was, “Okay, how am I going to predict the future?” It’s like a totally different question. You know what I mean? I would argue that it’s much easier to answer, and I know I’m putting words in your mouth, but it’s much easier to answer your question, which maybe that’s not how you look at it, but that’s how I see your trading, is what can I do to set myself up so that when the market moves, I’m going to take a big chunk of that profit. Right?

Darren: Yeah, definitely. The thing is is with those complex things, you can always make them work. That’s the trap is because it’s complex and it does work some of the time, you’re more compelled to believe in it. We get back to this thing about what you believe in is really important, but the problem is is their more susceptible to the unusual event. Although it can, like you say, win for a while, it needs a small change in what the market’s doing for it all to come crashing down. What I try and do is say, “Okay, what’s doing to work in all market conditions? If the market stops trending, am I going to get wiped out?” I try and sort of build it around what’s happening all of the time, rather than just specific patterns. That way, I think your system becomes more robust. I think a lot of the difficulty is is deciding how to simplify a system because it’s very easy to say, “Well, you need to keep it simple,” but which elements then do you lose and which do you keep in? Which elements are important?

For that, I think you have to look at the big context, which is my personal opinion and it is my approach to trading. Again, I’m not saying it works for everyone. I was chatting to a trader this morning and basically the point I was making to him was if you use trend and then you either use a wide stop so your win rate is high or you use a tight stop and let everything run so you always get the big wins, then essentially, that is all you need to do. He came back to me, “But I know two very successful traders that use tight stops and small wins and they do really well.” Again, this is that little complex trap where there’s a few exceptions and because it’s the hard way to go and someone’s achieving success with it, you’re more likely to believe it than what’s really obvious in front of your face.

Like I said, this is just my opinion on trading and it gets a lot of people’s necks up because it is very different to what we usually hear from traders, but if you read any of the market wizard books, they’ve all got their own take on trading. Very few of them follow the same path. It’s my opinion, it’s a little bit out there, but for me, that’s one way of simplifying it. I’d say use trend and think about stop placement and then how big your wins need to be to make that a profitable scenario. It’s very simple. It’s my opinion.

Walter: What’s interesting about that is what you’ve just described, your approach, is exactly the opposite you would take when you have a really complex algo that you’re working with because you’ve really whittled it down here. You said, “Okay, well what elements do I need to really focus on here to make this work?” Whereas when you’ve got something complex, and I think Taleb would agree with this, what you essentially have to do is you have to anticipate the weaknesses of it. You have to build in … It’s sort of like building a nuclear reactor. Right? You’ve got this really complex thing that harnesses energy and turns it into electricity, and what you’re to do now is say, “Okay, now what are the things that can happen than can cause a meltdown here and how do we build safeguards in for that?”

That’s what happens when you build something that’s interdependent on itself and really complex is you’ve got to anticipate where it’s going to fall apart and how to get around that, or how to avoid that. That’s much different to something that’s simple and robust because it has so few moving parts. It’s sort in its very nature more robust, so all you’re really saying there is, “What is the core thing that I need to focus on here to make it work?” It’s almost the exact opposite. In one, you’re looking, you’re trying to anticipate the destruction of the system. What’s going to make it come down because it’s so fragile? Then the other one, it’s trying to just pick the one thing that’s going to make it chug along, the thing that’s going to fuel it.

I find that fascinating and I think that for a lot of traders, it takes time to come to that point. I don’t know what your experience was like Darren, but for me, it sort of really took time for me to come full circle around to the point to where I am today, which is making it really simple and not adding too many layers or filters over the way that I look at the market. It wasn’t always that way. Before it was always, “Okay, well this works pretty good, so if I add this element, if I just add Bollinger Band here, then I’ll be able to filter out these losers and that sort of thing. It can get out of hand rather quickly.

Darren: Yeah, definitely, Walter. I think what I did personally … Well, a thing that fascinated me was how come we’re all making the same mistakes? What is the solution to all those mistakes, really? Generally, you have the people who like the really accurate entries with tight stop blocks. Obviously, a lot of those get stopped out, and then when they do get a winner, they closed it early. They would do it in tight stop blocks, small win. Then, invariably, even if you were good at that, you were ending up break even. Then you had people using a wide stop and then trying to get long runs with that as well, so then not get in a high win rate.

For me, it was looking at what everyone’s doing and surely that’s going to be the answer. It goes back to this idea that ninety-five percent, or however many it is, lose. Surely, there’s something that we’re all doing in human nature that is making us lose. Then, okay, so I’m just going to reverse everything and do the opposite of what everyone’s telling you to do and maybe … That lead me down a path. I mean, essentially, I’m looking to start trading at point A and exit at point B and not … As long as there’s a difference between those prices, there’s opportunity there.

It’s the way I see it, rather than looking for a particular event to happen and decide, “Well, now is the time to get in because I know it’s going to go to a certain place.” I removed all of that trying to predict what’s happening next out of my trading because that killed me, as well. I found it really, really frustrating. I’d get to the end of a day and my head would be pounding if I’d had a bad day and, “Where did I go wrong? What did I do wrong? The pattern was right and everything was lined up, why did I lose?” Then the next day, the pattern’s not quite so not quite to your complex system you have.

Then you get out early because you built up fear because it’s a perfect entry. Then that one goes on to where? You know, just get trapped in a circle of second guessing your own analysis. I just find it a lot easier to have no discretion at all on the entries, really, and take all of that. Consider them all to be a guess, if you’d like, really. Then it’s how you manage those ones that survive and where you exit. That is the important bit. It, in a way, reducing the amount of involvement I have to have, so I’m just using my mind to get decisions to get good exits, rather than on the entry as well.

Yeah, slightly going off course there a little bit, as we normally do. Essentially it’s trying to simplify the whole process, really, rather than making the entry, the management, and the exit all very complex. I think that’s really near impossible for a lot of people to do and I’m not saying there won’t be exceptions throughout and people who are particularly talented at doing it, but clearly for the majority of people it’s a really hard skill to do.

Walter: I think you hit on one of the central keys to it. It’s sort of like a zen-like attitude of it, just let it be, just let it go. It’s not something you can get attached to because it’ll do your head in, right?

Darren: Yeah.

Walter: It reminds me of this trader that I read about and I would like to meet him. I believe he is still in Australia, but there was a book called Every-day Traders by Nick Radge and the interview was mostly they were stock traders and systems traders, like automated systems traders and things like that, but basically there was one currency trader in the lot and his name was Scott Barlow.                                                        

I thought what he did was fascinating because it’s very similar to what you just spoke about, Darren. He said that he subscribes … Okay, he manages money and he subscribes to a signal service. Okay? All he does is he takes the signals as they come and he manages the trades with a three-to-one reward-to-risk ratio.

He doesn’t actually pay attention to the exits that are suggested or anything like that. All he does is in the signal service, he just takes the trades as they are offered to subscribers and then he sets a three-to-one. That’s all he does and those trades will either hit the stoploss, and he’ll lose one, or they’ll hit the take profit and they’ll hit three. He said, “The reason why I do this, the reason why I outsource my decisions,” he says, “Look, it’s my job to manage the exits, so I just go three-to-one and I never moved to break even.” He never does any of that, he just lets it go.

He says, “I don’t want to beat myself up over the decisions, whether to get in or when to get in and which market and all that. That’s why I’ve outsourced this.” I thought that it was a really interesting way of sort of psychologically of releasing yourself from beating yourself up from that guilt or whatever you want to call it that comes with making the wrong decision.

Darren: Yeah, and why not? Why wouldn’t it work? I imagine whoever is giving out the signals is using some sort of trend, you know, picking pairs that are trending to give the mostly winners. I’ve seen data before where random entries make profit as you increase service-to-reward ratio.

Walter: Yeah. That’s right.

Darren: The difference is can you do it? Can you believe in it? Can you wake up everyday and do that and not start to want to think that you somehow are going to be able to pick a better entry. It’s whether you can execute those simple strategies. That’s quite a hard leap to make if you’ve been down this path where you somehow are going to have a really accurate system and I think that’s kind of a major hurdle for people. Yeah, I find it much easier to believe in systems like that and many of the ones that I see people using like that.

Walter: Yeah, the seduction is in the win rate, isn’t it? I mean, the seduction is in … Let me ask you. You’ve got a simple way of approaching your trades, and how do you convince yourself that what you’re doing is right and that it’s going to work in the long run? What’s the trick for you?

Darren: Well, I do a lot of back testing, even when I’m trading live, so on the weekend, perhaps, if I’ve had a bad week, I would just pull out some random data and run a back test and just really enforce in my mind, “No, okay, no. This system works, I just, you know, I’ve had a bad time, or I’ve executed it badly.” I do that. Also, I’ve got my memories of losing as well. I don’t know who it was, but I remember someone said, “Enjoy your losses because you’re going to learn a lot more from them than you are from the winners.” I completely agree with that.

I think you kind of get to the end of the line, as well, where you’ve tried a certain approach for a long time and you’ve beaten yourself up about it and you’ve gotten to the point where you think, “This just isn’t going to work out for me,” and you say, “To hell with it, I’m just going to do the opposite of what I was doing. I’m going to just put the trades on and walk away and forget about them.” I think I got to that point, as well, many times in my trading. Yeah, I think perseverance as well. It’s almost an alien thing to be able to trade, so you have to do a lot of looking within yourself to become a good trader, I think.

Walter: What do we do then? If we believe this is true, that we want to simplify our system and we don’t want it to have too many moving parts, we don’t want it to be fragile, we want it to be robust. How do we do that? Someone listening here saying, “Yeah, sounds good, but I don’t know how to do this. What do I do? Where do I start? How do I create something that’s anti-fragile?”

Darren: I think the only technical element that is going to give you a slight edge, in other words, give you a sort of guaranteed more than fifty percent win rate is a simple use of trend, so use something very simple to decide what your trend is. You know, a move in average, lower lows, lower swing lows, lower swing highs, something simple like that, but make it really simple and non-discretionally, so there’s no questions that it’s above or below the moving and then that tells you what the trend is. There’s no ifs or buts to that, nothing else changes it. That’s the first one.

The second one is I really believe this idea of even if you want to use a tight stop on your trades, I think unless your wider stop is really beneficial and by all means move it up after price has moved away. I think what a lot of people like to do because they think no removing risks is they like to use a very tight stop behind the entry and then as soon as price moves, they like to move that into to secure some win too quickly. Okay? This is like a fear move, okay? “Excellent, I’ve got a winner. There’s no way I’m going to let this become a loser or a break even, so I’m going to grab a bit straightaway.”

All the data I’ve seen says that that’s a really bad thing to do. By all means, start with a wider stop and when prices are moving away, reduce your stop. Okay? I think people are just a little bit too tight when they first enter and a little bit too quick to move the stop up, and that basically makes your job a lot harder. If you do want to use a tight stop, I think you need to then accept that your exit needs to be larger that, say, a one-to-one or a two-to-one risk-to-reward. To really give you an advantage on a money management side, you want to let your trades run and a few big wins will make up for all those stops that get hit.

My personal preference is to use a wider stop and then basically make my judgement when I see how price has moved away, so if I start with a wide stop and the price moves dramatically away and the trend continues strongly, then I’m going to let it run longer. I’m using a judgement call then. I’m looking at it, there is a trend, it’s moving strongly in that direction, no news has come out to counteract that, so I’m going to let it run. If I’ve entered initially with a wide stop and it looks like the trend’s kind of faltering and it’s doing double bottom, triple bottom, whatever, and prices are stalling, then I’ll take the small win. I’m insuring a high win rate, but I’m also giving myself an opportunity to get the wins as well, so it’s like the best of both worlds, really.

Walter: Right.

Darren: Yeah. For entry, a lot of people ask me about specific entry types. Just use something simple and repetitive and use something that’s going to give you a decent frequency of trades. If you’ve got too few trades, I think it’s really hard to maintain a system. You’ve got to have a very strong will to only take a few trades a month and I know it’s when you … You trade much higher time frames, don’t you?

Walter: Yeah, I think so.

Darren: Yeah, but you then look at many more instruments to find your … That raises your frequency. You know, a lot of people ask you how many instruments can you trade and what time frame. Really, that element, you’re looking for a decent amount of frequency, so you give yourself a decent probability of having some winning trades. If you take one trade a month, you’ve got very few opportunities. That’s my personal view, but it’s certainly not the only way to do it…

Walter: Yeah, that’s interesting. I heard about this guy who traded, he did the op- … Well, not the opposite, but he did this thing where he would just pick, I think he actually automated it. What happened was the system would take these trades and it would lose like ninety-eight percent of the time and it would just try and pick these turning points and you have a really, really tight stop, like a few pips. He would, of course, get stopped out almost all the time. Well, once in a while he would get hook into one that would just go and he would just leave it open. He would close the trade eventually, but it was sort of like trying to pick a sixteen week trend on the five-minute chart or something like that.

Of course he failed miserably most of the time, but once in awhile, he’d hook into these with two pip stops or three pip stops or something like that and it would just go and go and go and it would cover all of his previous losses. I don’t think that’s necessarily one that most people could do. I think an easier one would be to look at the line chart, so if I were a trader and I wanted to simplify things, what I might do is probably somewhat similar to what you do or I’m not sure, but you would say, “Okay, look. The euro’s going down. Right? I want to sell the euro-dollar. I see that it’s making lower lows and lower highs on the line chart, so what I’m going to do is wait for it to swing and go up and go against the trend and then as soon as it makes on of those nice bends back down in the direction of the trend, I’ll just get in there.

You could just do something like that or you keep stacking those whenever you see a trending market make a turn, you just assume that it’s going to keep going lower and lower and lower. Same thing with Bullish Trends. You just assume that when it makes that buy … You could stack those on and that would be a really simple way and it probably would fit with, what you’re talking about, with a wider stop. My interest, though, is when you say it’s a judgment call about how far you let it go. How do you know? Is it just based on sheer velocity? You see it seems to be going really strong in my direction, so you assume it’s going to keep going further? You mentioned you don’t want to hear any news that’s counter to the trend and things like that, but I think a lot of people might be listening to that, Darren, and saying, “Oh, I don’t know. That sounds a bit iffy.”

Darren: Yeah, but I really think that that’s the way to do it. You have to look at the real big picture and the context, so let’s say it’s been stinking for you for ages, and you finally got a nice runner and a decent win. You might decide, “Well, I really need to cover my loses here and take a little bit of profit and get back on a … It’s been a nasty, rangy period and this is going to get me out with a small bit of profit.” In this context, okay, I’m going to call it a day and close it. Let’s say, for instance, two of your pairs have not been doing great, but the other two are in a really nice trend and you’ve got two big wins going. Well, in that case you might say, “Well, you know what? I’m going to take half the profit off that one and then let the rest of it grow.” I think a lot of being a trader is making good judgment calls. If you’re going to say, “Well, I’m not going to use judgment calls at all in my trading.” Then are you basically saying that I’m not going to be a good trader?

You think about anything else you do in your life that you’re good at. I am particularly good at cooking. I can chuck a sea bass in the oven. I can pull it out, I can touch it with my finger and tell you if it’s cooked perfectly or over-cooked or under-cooked, within an instant. There’s nothing that’s telling you that other than good judgment, and I think the same thing must come into trading. Surely, you must be able to sort of judge your, you know…

Same if you run a business. You get particularly good at judging what stock to buy and how to staff certain events and these are skills that you haven’t gotten any specific measurements that are giving you the whole answer, but you’re using your judgment and experience as well. I think experience kind of comes into it a little bit.

That’s how I see it, really. I think a lot of people seem to think that they can draw a line on the chart and be more accurate, and I question that massively.

You can pick some good areas to get out, but how many times have you put that weekly support and it sits on it for two days, and then drops for another three hundred pips. I think people believe what they want to believe. If they use support and resistance for example, they believe in that. It’s not right for everyone, but for me it feels comfortable because there’s no right or wrong. I can’t beat myself up if I take an exit and price drops again because you’re going to be wrong sometimes. You can’t predict. What does help, though, is have a system where you can reenter, which is something I get from using Breakout. If I do exit and it looks like the trend’s continuing, I’ve a valid entry to step back into the trend. Yeah, maybe a bit vague, but it works for me. I think when a lot of traders play with this idea, it’s not as mad as it sounds.

Walter: Yeah. I think one of the things that’s coming through, just to wrap up from my end, is, I think, the experience that you get is really what’s going to help you. I believe that it doesn’t really matter, even if you’re trading at a completely different, even if it’s a more complex system. Having that experience in the markets and seeing the markets and banking that experience and seeing that chart, having those all in your mental file is really helpful. I would encourage people to … I knew a trader who would just load up Forex Tester and he would just let it run and just watch it like a movie. He wasn’t actually trading. Most traders, of course, when they’re back testing, they actually take trades and make decisions and pull the numbers out of there and look at their data and all that, but he was actually just watching it in terms of “let me just see what happens here” trying to experience the market.

I think there’s something to be said for that. If I were a trader and I were thinking about simplifying my approach to the markets in the hopes of perhaps doing better, what I would say is definitely try and get more experience. You can manufacture that by look at the older charts, by using Forex Tester, by doing things as if you were trading back historically. It doesn’t really mean that you’re going to see the exact same thing in the future, but what it means is you’ll have more of those experiences in the bank.

Also, seriously look at systems like how Darren trades, which is basically to look for really simple reasons to get into the market. Right? Like really simple. In that way, what you might do is find one that resonates with you that makes sense to you and fits your beliefs of the market as we all trade our beliefs, and then you can stick with that over the long haul. That’s my basic take away from today. What about you, Darren?

Darren: Yeah, likewise, really. If you’re struggling in trading, just think about what elements you could perhaps remove from your trading, what elements are really important. Perhaps try something a lot simpler for a while and see if that makes a difference.

Walter: Thanks for your time, Darren, we’ll see you next time and until then, happy trading.

Darren: Yeah, cheers, Walter. Good bye.

Walter: See you. Bye.