Can the “Double Ace of Diamonds” help your trading??
In this episode of 2Traders Podcast, Darren and Walter look at a major trading issue (every trader goes through this eventually). You’ll see how to focus on making the “best trading decision” may not be the best way to trade. Darren will also show you why he uses a poker player’s strategy with his trading, and why.
Also, you will get the “golden nugget of truth” rule that can really help your trading, all this and more in this episode.
Download (Duration: 22:36 / 25.8 MB)
In this episode:
00:40 – ace of diamonds
02:05 – last piece
04:48 – all chips in
06:59 – locked-in
09:30 – harmonic traders
11:06 – pretty, good decisions
14:31 – power of exit
16:06 – large pot
18:36 – demoralizing
20:05 – roulette
22:04 – icing on the cake
Walter: …Keep reiterating, keep changing, keep modifying, keep trying to make it better, better, better. And then, pretty soon what you’re left with is a great system for trading the last 90 trades and has nothing to do with what’s going to happen in the future and it’s not going to help you at all…
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 Broadcast.
Walter: Welcome back to the Two Traders. It’s Walter here and in Part Two of this episode, you will see what’s the double Ace of Diamonds card and how it affects traders. You’ll also see how Darren uses the poker player’s exit strategy with his trading and why.
You will get the problem with really big winning trades and this can drive some traders crazy but it shouldn’t and you’ll see why. You’ll also learn why focusing on making the “best decision” may not be the most profitable way to trade.
And finally, you’ll get the poker player’s rule that can help every trader who pays attention to this golden nugget of truth. All these and more in Part Two of today’s episode.
… Yeah, absolutely. So, taking crunch to numbers and say 83% of the time when it hits R3, it retraces 25% of the move from the whatever. The daily pivot, the middle pivot or whatever that thing is called — I don’t know what they call it.
Anyway, they can do things like that. They can crunch all those numbers and everything and it gives some comfort to say, “Look, this is what’s most likely to happen and I’m so happy to take these trades.” Those are the sorts of things that a lot of traders do, specially mechanical traders, automated traders. They do a lot of that stuff.
I’m just trying to figure out the difference and I guess between that and the poker player who knows the odds of certain hands and all that. I guess, it’s a very good analogy and it fits completely.
Except for that last piece which I believe is you’re dealing with what I call “close system” because there are no like double Ace of Diamond cards or something. You know what I mean? That card doesn’t exist.
You know what I mean? Whereas, in trading who knows what kind of card you can come up with. It’s just like unlimited.
Darren: Yeah, and the open element is the betting side of it. It’s the money side of it. So the poker player, it hits it’s R3 and now he’s in the trade. He’s in the hand. It’s what the other players bet so, “Okay, I’ve got this good hand. I’m in,” and then player 3 drops his whole stock.
Now, the game is completely changed because you still have the same hand but now if you want to play on, you’re going to have to risk your whole bank row to stay in the game and now you have to make a decision.
It’s exactly the same with trading. You know the price sets to R3 you get into there, the trade, you set your stop loss. Now, you have to have a strategy to make the most out of those trades.
What people tend to sort of via towards is having more winners than losses so they tend to get out of that trade quicker but that isn’t necessarily the way to make money from it. The way to make money from it is probably more likely to let it run it a bit further and then start cutting your losses short of the winner by some sort of trailing stop.
In my mind, that is the most profitable way to trade. It’s to try to make the most of your winners but when you’ve got a decent win on the table then you need some sort of trailing stop. I think that is where the most edge can be found. That’s my belief.
I am not saying that I’m right but that is 100% my belief and that’s why I don’t really focus on the entry. I’m thinking more about the exit side. I think for me, that is the best strategy and I think maybe a lot of poker players think that way as well.
For sure, there’s the good poker players, they’ll wait for specific hands. They’ll play them but then if someone… Everyone else comes in really heavy then they might say, “Okay, this is a good hand but it’s looking like everyone else has got a good hand so I’m going to move my stop up and get taken out and I’ll wait for the next hand”. I believe that’s probably how they’re playing it.
Walter: Yeah, that makes sense. See, I think it’s different from trading. The way you’re describing, you’re saying how you and I are playing poker and I push all my chips in and so that forces you to make a decision.
You either dump your hand right there or you have to go all in too or whatever is much better, whatever it is, or whatever the rules are. I don’t know but you have to do that. In trading, if I’m on a GBP/JPY — like right now, I’m on a GBP/JPY sell trade and it hasn’t quite reached my target — I have another position with a trailing exit but like it’s retracing against me now. It hasn’t hit my break-even stop but it’s retracing against me and I don’t have to take another position or take on any more risk even though it’s going against me.
Whereas, if I’m on a poker tournament and someone goes all in, they are forcing… They’re sort of forcing my risk management rules to get a little what I would consider to be quite risky. That’s kind of, I guess that’s the nature of poker.
Whereas in trading, you don’t necessarily have to do that, right? You don’t have to… I mean, it maybe your instinct to do that but you don’t have to, right?
Darren: No, but you’re looking at your account balance. No more of that is at risk but your equity is at risk. If you’re H5 is up and you do nothing and price comes all the way back, that you still lost H5.
The fact that you don’t already bank it, it’s by the buy that was profit that you had that you could have taken and you’ve given that back. So the bigger your win, imagine if you’re a trend trader and you’ve been holding a trade for 3 to 4 weeks and you’re up 30 hour then you’ve got 30 hour that’s open to risk.
One massive crash in whatever you’re trading and you could lose all of that so I think it depends if you look at it from trading balance or equity.
Walter: Yeah, that makes sense. That makes total sense. Yeah.
Darren: That’s why I think the trailing stop works so well because this is the notion that you’ve got like trail it behind every bar. You don’t. You can just take a trade and let it develop and then, “Okay, well, it’s gone 30 hour or 10 hour. Now I can, I’ll lock-in 4 hour”, so you’ve locked-in some profits but you’re still letting the trade run. Personally, it’s one the most underutilized tools in trading but that’s because it’s so difficult to do.
Walter: Well what? Using a trailing exit or what do you mean?
Darren: Using the trailing exit because we want to find the definitive rules. We want to find at 3 hour move to break-even at 5 hour locked-in 1. We want to be out to design a simple rule set and that always be the best.
It will be great for a while and you’ll get one that just doesn’t fit the program and you’ll lose a lot and then you’ll change it and you’ll change it again. Whereas, I think really what you need is just some loose rules to it, really, because you’re not going to find… You’re going to find the optimum for the last hundred trade and then the next hundred trades, it would have been a completely different pattern.
You really need to stop worrying about getting it perfect all of the time. What you need to worry about is that you’re catching some really big winners and some of that go away for a bit and come back on complete losses. You’ve just got to need to find a balance really.
Walter: Yeah, that makes sense.
Darren: And we don’t like that, do we? We want to know that we have got the optimum X, or whatever it is called, for every element of our strategy, that’s what we want to know. If it turns out bad 1 or 2 times, then we change it and we look again.
Walter: Yeah. I think a part of that too of that trailing exit problem is that we don’t like giving back what we already have. We don’t like the fact… I mean, the fact with the trailing exit is you’re always going to give back some equity in the trade. Like, you had 400 pips on the trade and you get cashed out at 360 or whatever, right?
Darren: Yeah, I think that’s more painful. The funny thing is with the fixed target, you’ll often do that anyway. If you’ll look at all of your fixed target exit, you’ll see that so many of them went further.
You could say this about every exit almost, unless it’s like like right every low of the year pretty much or right every high of the year. Pretty much every exit is not going to be the optimum exit but we live with this belief that we’re going to write the system that gets us that optimum exit all the time. We really hold on that belief strongly.
Walter: Yeah, you’re right. That reminds me of the harmonic traders who have these crazy patterns that I think it’s part of the draw of these harmonic patterns. It’s that they say, “Look, okay if you see this pattern then this is your target. Like, it’s going to go to here.”
It’s going to do this 261 extension or whatever, that sort of thing. It’s just like it’s trade by numbers sort of thing. Yeah, you just plug it in and go. It makes sense to people that it would do that.
I think the clever traders will look at — and I don’t put myself in this category — these traders who look at MAE and MFE, Maximum Favorable Excursion and Maximum Adverse Excursion, and they kind of… What they are really trying to do here is grade themselves on their trade and say basically what you were talking about, “Okay, well I have this target and how much more could I have had on these trades?”
I don’t know that it fits into an average though. Like, if I look at 600 trades and I said, “This is where my maximum favorable excursion was on this trade and this is the amount that I left on the table.” I think you have to be careful because when you’re talking about averages and stuff like that, there’s going to be a lot of trades that’s fallen either side of the mean. And so, how do you deal with that? What do you do?
Darren: Yeah. There is a saying, a comment, well it says something like, “You want the best and then you miss the good,” and we kind of we… Because we’re trying to find the best all the time, we miss out on the good opportunities.
Darren: Kind of what a saying is.
Darren: A pretty good decision a lot of the time will do. We’re trying to make the best decision all the time and that’s not really what you need to do. You need… Like, you need a long sequence of pretty good decisions rather than just trying to get the best decision.
Walter: Yeah and that’s the road that leads to curve-fitting when you do that. When you just keep reiterating, keep changing, keep modifying. Keep trying to make it better, better, better and then pretty soon, what you’re left with is a great system for trading the last 90 trades and has nothing to do with what’s going to happen in the future. It’s not going to help you at all for the future trades, the next hundred trades. It’s just a problem, yeah.
Darren: I wonder, statistically, if the best poker players do for a way most of their hands.
Water: See, that will be interesting and I wonder if someone actually study that. That’s interesting to me. Yeah.
Darren: Yeah. And I think again, a lot depends on not just their hand. It depends on what the other players are doing as well. When the market… Let’s say, you’re really cautious with picking your entries and you’re super picky about it. When the time just bomb in and you know it’s been bombing on all last week and nothing has changed fundamentally and it’s bombing again, then perhaps you should loosen up your entry statistics and make a sunshine sort of a thing. That’s the same in other elements and so, as always, we just focus on that particular, really stringent, entry pattern and I think that’s just the mistake.
Walter: But, what if the trader has impulse control issues or whatever and so staying inside the white lines just helps them execute better? Is that something that —
Darren: I think that’s fine as long as you’re fully aware that it’s really other elements that are going to make you money over the long run. I think that has to come on the money management and the trade management as well.
Thinking you can just find a really good entry setup and I think it’s going to be fine ,then mind what you do afterwards whether you go for 1 to 1, or 5 to 1, or trailing stop is wrong.
That’s easily proven by looking at the same entry and comparing different exit strategies and seeing really you should have similar results across them and I think that would be unusual if ever happens.
Walter: Right. That’s interesting.
Darren: I’ve seen it. I’ve seen random entry tests with random exits and fixed target exits, trailing stop exits, and the gamut of results very, very massively. To me, evidence proves that it is not the entry that holds the biggest edge. I could be wrong. I’m sure people disagree with me and that’s cool if you’re making money. It doesn’t matter what I think.
Walter: Right, that’s interesting. I mean, I encourage traders to do the random entry tests but with a really high hour exit but just to see the power of that exit because so much is placed on the entry. I think that can be a really useful exercise.
I’ve heard of traders who, like if they have a strategy — let’s say they have a strategy that uses a certain setting on the MACD or whatever to enter into a trade — and then what they’ll do is that they’ll just plug in totally random settings into the MACD completely different from their trading system to see if the strategy still holds up when you totally change the entries. Things like that just to try and figure out, is this just kind of a random result or is there something there? That’s the thinking.
Darren: Yeah. And, I don’t want people to think that I’m saying that a random entry is best and there is no edge in an entry strategy. There is but it’s fine and you’ll need a little bit more than that.
Walter: Right. Now, Darren, while we’ve been sitting here talking about poker players, I’ve seen this. I’m just reading this book, it’s from the book called “How To Make A $100,000 A Year Gambling For A Living”, and it’s talking about professional poker players.
It says professional poker players always consider the size of the pot before making any decisions. Almost all other authors, when describing how to play a hand, ignore the pot size.
It says many professional know that as the pot gets big, hands should be played much differently than when the pot is small. Obviously, they know that the bigger the pot, the less likely it is that they should throw their hand away. Isn’t that interesting?
In a large pot, they know that you should try and win the pot instantly or at least cut down the field with both fair and good hands and then, in smaller pots you should be more likely to throw away your mediocre hands.
So, why would that be the case? Why is that case because I don’t understand that? I don’t understand why that would be the edge? That in a large pot you should actually go for it basically and get really aggressive. Why is that?
Darren: Because, let’s say there’s a table of 5 players and all of the other 4 players have put $10,000 in, so you need to put $10,000 to stay in but your potential reward is $40,000. You have a 4 to 1 risk/reward to stay in.
With a very small pot, you don’t have that risk reward. This is what I always try to say with… I know everyone, I know people can make profit at 1 to 1 risk/reward but your edge is slimmer and I presume that’s why he’s saying that.
Walter: Right, that makes sense to me now. I see and it’s true. It’s true and I think what you’re saying about the 1 to 1 systems, they feel really good. It’s nice to be a winner and all that but as soon as you slip up, as soon as you start to get off your game or even just have an unlucky streak, even with a 78% win rate, you can have an unlucky streak.
If you don’t keep executing your system and you start to switch it up a bit, you can really run into trouble. I agree. I mean, it’s almost like the 1 to 1 system with $1 risk for $1 reward, those systems. I almost want to say they require a different type of trader, like a better, more vigilant, more disciplined trader.
Then, if you think of it, like a scalper who might have like a 0.7 to 1 system, that makes sense. I mean, they have to be very, very disciplined. They have to have certain rules in place and they just can’t go off the handle.
Whereas, if I am trading my 39% or 37% win rate system, I can get a little bit sloppy and still come out ahead because the average winners 4 to 1 or whatever. It’s not going to hurt.
It just gives you a little bit more cushion but the downside of course is that you’ve got to work on your psychology because boys are painful when you’re trading a 38% win rate system because you’re going to have… The most likely result is the next trade I take is a loser. It’s just demoralizing.
Darren: And, you’re just limiting every trade’s potential as well. Once or twice a week, if you trade on lower time frame or once or twice a month from higher timeframes, there’s going to be a trade that just goes, just rockets.
Even if you require a higher win rate — I mean at that 1 to 1 — then reduce your risk by half or move to break-even and just give yourself a chance of getting those insane ones where it just goes straight.
That is the least… The thing that happens least often is price just gets up and goes in one direction really hard but you want to be in that game. You want to give yourself a chance of getting those at least.
Walter: Yeah, absolutely. Here’s my final recommendation on this poker thing. I know we’ve taken two episodes to get through all these but I think I’ve really like the idea of trading with multiple — well, you can call it multiple trades — but it’s taking one trade and splitting it up into different exit strategies.
Like a trailing exit, a 2 to 1 target, some sort of money management where you’re adding to it as it goes towards the target. All of these sorts of things, I think it makes sense because you’ll never really know what’s going to happen with this trade and one of those exits is bound to be the winner.
It’s like the way of roulette, actually. It’s funny that you mentioned roulette. The way I play roulette, I know it’s a losing strategy, I know there’s a negative expectancy but I play in a way where I’ve covered a lot of the numbers.
It takes a long time for me to lose my bank on the roulette table and in fact you can get to the point where you have a little lucky streak and just walk away, which is always nice when knowing you’re trading a negative expectancy system.
That’s what I will encourage listeners to do is to think about each trade you take use different exits, completely different exits, so that if it really goes the trailing exits, takes advantage of it. If it goes quickly to a target, the pyramiding strategy takes advantage of it and if it just goes a little bit in your favor, maybe that your target takes advantage of it and the other ones don’t do as well.
That way, it’s not so demoralizing because if you’ll use just one exit strategy, it might make you more money but it’s just harder to stick to because you’re going to feel like you need to change things up because of what happened on the last trade or the last 5 trades, and that’s being human trying to adjust and change things up. But, I think it makes sense to me what I found to be useful is just to split it up and make multiple exit strategies.
Darren: Yeah, I really like that idea. I really like it. I haven’t tried that but I need to look at it for sure. For me, the final point really is definitely look gambling and trading in a different light because I think people that say that trading is different to gambling, they’re in the mindset that the biggest edge they have is selecting their entry.
They might be well be right but as far as I’m concerned, you’re missing the icing on the cake there and I think if you have a kind of a broader idea of what makes trading work, then you’ll see that there is a lot of parallels between it and gambling.
Walter: Cool. Thanks, Darren, for your time and we will see you next time.
Darren: Okay, Walter. Cheers!