Will a trading system limit your profit potential?
In this episode of 2Traders Podcast, Walter and Darren unravel the usage of trading systems. Do they offer opportunities or just limit you? Do they hold back your profit potential? They also talk about the two types of traders and how you can identify which one you are, based on your psychology.
Darren shares his “bigger strategy” and how everything just boils down to this one thing… (Do you know what the “one thing” is?)
Walter gives insight into the idea of trading as your “boss.” Why do you get up each morning? Does you strategy
become your boss when you no longer have one? All this and more in this episode of 2Traders Podcast…
Download (Duration: 24:01 / 27.5 MB)
In this episode:
00:53 – gambling away
02:00 – magic
04: 39 – limiting opportunities
07:29 – three rules
09:12 – just one thing
11:34 – overseer
13:22 – precise rules
15:23 – accountability partner
17:40 – discretion
19:25 – coded rules
21:19 – an illusion
23:13 – like a boss
Darren: When you’ve been through the grinder a lot of times, and made lots of mistakes then you realize that sometimes you’re better to be, have slightly lower profit but greater risk control.
Announcer: Two Traders, Darren and Walter, pull back the curtain on profitable trading systems, consistent money management, and profitable psychological triggers. Welcome to the Two Traders Podcast.
Walter: Welcome to Two Traders. Walter Peters here and I’ve got Darren on the line here. How are you today, Darren?
Darren: I’m very good. Thanks, Walter.
Walter: Excellent. Darren, we have a question here. The question is does strategy define your trading opportunities? In other words, is the main thing that your strategy does, is it to simply limit you from gambling your trades away by just going with your gut whenever you feel like? Is that really the main function of strategy, to limit you or restrain you from going hog wild? What do you think about that?
Darren: That’s kind of… It’s a yes-no answer, I think on this. Certainly for me, I mean, if we’re talking about strategy, if we are talking about the rules about when you enter and when you exit, for me the majority of my rules — at least in my mind, anyway — are there to give me some sort of structure to work around.
To make trading psychologically easier and I’m working on the part of my strategy that makes the profit. It’s the fact that my winners are much bigger than my losers.
In that respect, like for instance my entry setups that I use will just be there so I can say, “Okay, it’s acceptable to take a trade now.” And, I don’t believe that there’s any sort of magic going on there. Like, it’s in the zone and that means that this is what’s going to happen next.
The majority of my strategy is there for that purpose of just making it easy for me to execute the strategy. I don’t think that, that’s necessarily true for everyone but I know other traders… I read a Nick Radge book. You know Nick Radge?
Walter: Yeah. He invited me to his conference thing. He’s a good guy.
Darren: Yeah. He had a book where he said that all of these elements, like the moving average and the candle pattern and all of that, are not the elements that are going to make you a successful trader, and I kind of go along with that.
And he said, “Those elements are really there to give us a level of comfort,” because we need that level of comfort to be able to pull the trigger. At the same time, I know you’ve mentioned before traders who just get up in the morning, they’ll look at the charts that’s been, “Well, I’ve got a feeling it’s a down day. I’m going to a take a sell.” There’s traders that do that as well.
It’s difficult to say yes or no on this because I think trading strategies come at trading from so many different angles and can be complex and simple. I mean, this is why we’re always saying you’re trading strategy has to be your own because you can have your own little take and feel on where opportunity lies in the market.
If someone comes along and tells you this is how it’s supposed to be, you might be able to go along with that for a short while. But, at some point, your psychology is going take over and you cannot back against that.
Walter: Yeah, exactly. It’s almost like if you don’t have your strategy then, then you’re in trouble because then that’s going to… It’s kind of like the guys are going to blow and you keep plugging the holes, trying to stop it from going and then it’ll just go if you don’t hold it back.
I think in the beginning when you first start trading, it’s because it’s all about the opportunity and it’s all about, “Oh yeah, I want to make a bunch of money.” I think it’s easy for most traders to get into that mentality of “I need to trade more often. I need to trade the lower time frames. I need to take more trades. I need to compound my small little account here and grow it really quickly. I need to take on more risk.”
I think strategy can hold you back from that and you just touch on that. One of the main things about strategy is not simply just limiting your opportunities and defining when you enter and exit for the markets but really it’s defining how you’re going to make money. In other words, the expectancy of your strategy.
What you’re saying is having a really high reward/risk ratio takes a pressure off because you don’t have to win that much. Well, I think strategy is good for curbing over trading and things like that.
I think the main thing that it does is — and again, I think you’ve touched on this –where you get into this comfort zone because you feel like even though you don’t know what’s going to happen on the next trade. You know that overall, your reward/risk ratio is set-up pretty well so that your numbers are all lined up and you’re probably going to end up okay a month from now, a quarter from now, a year from now, five years from now. It’s almost like it gives you comfort because you feel like you know what’s going to happen when really as traders, we just get paid for taking on uncertainty.
We take risk in the face of uncertainty and that’s why speculators get paid, really.
Darren: Yeah, definitely. A lot comes down to where you see the opportunity to make money in trading and there’s kind of your close-up strategy and your long distance strategy, if you like.
For me, the big picture is that price is always going to move and there’s going to be sustained moves within that. How can I then get into that without risking too much? And then, how can I stay in it and get a big win?
My focus really isn’t on the precise entry. It’s the fact that the opportunity is there so even if I’m just lucky, I have a chance of catching one or two of them and that might be enough to be profitable over the long run.
And then, really, when I’m getting close with my strategy, it’s okay. I’m going to have to get up and do this day in, day out and it’s going to be a lot of losers on the way. I need to make sure that when the market really doesn’t move that I don’t lose so much of my account that are not going to make it back.
Now, the strategy is just about controlling me. I want a decent amount of opportunities to try and grab one of these big winners but if the market is going sideways I don’t want to keep trading and trading and lose all my money.
I’m using my strategy for entry and managing the trades based on that big view and it really is as much there just so I can get up and do it everyday. I don’t think when the three rules lineup that there’s any sort of gray predictability and or it’s the best type of entry or it in itself has any particular sort of edge. It’s just kind of put me in line to try and work on that the bigger strategy.
Walter: What’s the bigger strategy?
Darren: Well, the bigger strategy is that the trends always occur. I look for one rule. I like to sort of try and grab a bit of a joke about this last week. I like to say, “Right, that is proven.” You can’t deny it. It’s proven, It’s true.
And so, if I’m going to base my strategy, my big picture on something, it needs to be something that at least I can put in that ballpark of saying, “This is true. It’s always been true and it’s always going to be true.”
I can’t prove that it will be true in the future but the probabilities are there. Well, for me that is, the trends always occur — and I don’t mean that price goes in one direction all year or for 6 months. I mean that price moves in one direction for sustained period.
That for me has always been true and always will be true. Within that, there’s opportunities to risk a small amount and win a big amount. Okay, so that is the big picture for me. That’s the truth that I’m going to try and make money on. Would you agree with that?
Walter: I agree that you’re trading your beliefs.
Darren: Good answer.
Walter: Yeah. No. I mean, I’m with you on that. I mean, like what you’ve just done, you just laid it out why as a trader you really need to sort of hang your hat on one thing and build everything up from there. So, your one thing is trends exist. They happen. We don’t know but they’re probably going to happen in the future. We may as well take advantage of those, right? I mean, is that fair to say?
Darren: Yeah. That is fair to say. I think, these other traders who will look at charts and say, “Well, at 8:15 on the Euro everyday, this breakout occurs and they go kind of really enclosed.” They can still make profit out of that.
I think, your belief doesn’t necessarily have to be true either because of the fact that price does move. I mean, if you have a really good money management strategy then it might just be that the one thing that you believe in isn’t actually true but your money management strategy keeps you safe if you like.
Walter: Yeah, exactly. I’ve seen an example of that where the money management strategy is just applied continuously to keep re-entering the market and it made money so there was no real edge, per se.
It was just the money management strategy, was the thing that made money and all it do was just… It keeps taking trade until the trade was over and when a loser will take another trade immediately after. They just keep doing that and it made money.
The other thing that I wanted to touch on because I think you’ve just kind of glanced off of it which was this idea that you wake up everyday and you’ve got this rules or the strategy that keeps you focused on what you need to do.
The thought that jumped into my head was if I were working like a regular job and I win in everyday and I had a boss — and if you really ask me — why do I get up? Why do I set my alarm in the morning? Why do I get up at that time? Why do I go and catch the bus or the train or whatever and go in to that office?
I might say, “Yeah, you know I need to make some money.” Or, “Yeah, I like hanging out with these people. They are good people” or whatever. But really, it’s almost like your trading strategy is taking the position that’s been vacated by your boss because you no longer have a boss.
If you’re a trader, if that’s how you make your income and it’s from trading, it’s almost like the trading system is the overseer. That, I think, is where a lot of traders run into trouble because who’s to know if I don’t follow my system. You know what I mean?
Darren: Yeah, definitely. And that’s a really good way of looking at it. I think the problem comes in fact that we think this is the boss and he kind of knows what he’s doing but, I tell you what, I could just — this looks like a good entry anyway. It doesn’t fit in with what the boss wants me to do but I will just take it anyway.
You can definitely trade that way and make money but it kind of glosses over the fact that when trading we kind of need that boss to tell us what to do. There’s certainly people out there that don’t need a trading system. I think that’s half the problem.
You can quite often waiting for your particular set-up and you can see that there’s other opportunities available because there’s endless opportunity in trading. It is very tempting to change the rules for this one and gets sort of pulled around. I think, generally, you’re better to have that rules set if what you’re looking for is longevity.
Walter: Yeah. I think Reima Huovinen who is at the London Conference, he was mentioning someone asked him they said, “You trade this engulfing pattern, this big shadow pattern.” And he said someone asked him and they said, “Well, if the pattern actually doesn’t fit like it’s off by 1 pip, will you still take the trade?” And he said, “No”.
He said, “I can’t”. He said, “Suddenly, I have to draw the line somewhere so if it doesn’t actually engulf the pattern candle, then it’s not a trade for me and I have to let those go” — which is really hard when you’re trading the W1 charts as Reima does.
That’s something that everyone has to decide where is the line. If you don’t have precise trading rules, maybe you don’t have a system. If you don’t have a system are you really going to be able to make it work.
Darren: Yeah. And, I think those kind of real marginal things, you have to accept that it’s not an expectancy thing. Just because the pattern is off by one pip, doesn’t mean it’s going to make a great deal of difference to the outcome but its the psychology and its the ongoing execution of the system. It’s the fact that if you tweak rules by a little bit then that can get out of control and then that’s when you kind of increasing your risk.
Walter: Yeah, exactly. I think that’s exactly what his point was when he answered that question was along those lines. It’s about the Psychology. The other thing that I think is interesting about this, Darren, is the idea of the risk manager.
If you’re working out in an investment bank or bank and they have currency desk, the risk manager is the person who makes sure that everyone’s kind of doing the right thing. They are the overseer.
They’re the one that comes over and says, “You’ve got 2:1 reward to risk to lighten up in your positions. You know what your number is. You’re above your number. What are you doing?” And then you do it again and the guy comes over and say, “Sorry, you’ve got to leave,” because they just can’t have that. They just can’t have it.
I’ve known people who had this job and I’ve known people who’ve worked at the desk and then left. What’s interesting is the number of traders who do really, really well at the currency desk and then when they leave, they no longer have a risk manager and their trading can completely tank.
And I think that that’s one of the advantages that institutional traders have. They have this setup, they already have it set-up to where they know that someone’s watching them and we know, like in Psychology, the observer effect. If someone’s watching you, you act differently.
I think there’s something to that and that’s why I encourage people listening to this to get a trading accountability partner. Someone that you can speak to every week and someone that you know who’s going to go over your trades every week and say, “Why did you do this? That’s not within your rules.” These sorts of things can really help you.
Darren: Yeah. This is kind of in effect the trading strategy is your risk manager. I touched on this the other week in my last video I did on the forum where I used a higher time frame trend filter.
If I take that away I make more profit but the opportunity to mess up and make mistake is increased by a massive amount. You’ve kind of saying, “Well, I’d rather have the safer lower profit than trying to hit the ball at the park.”
I think when you’re learning to trade, you definitely go for the one that makes the most money but then when you’ve been through the grinder a lot of times and made lots of mistakes then you realize that sometimes you’re better to be have slightly lower profit but greater risk control.
Walter: Exactly. And it’s about longevity, isn’t it? It’s about avoiding the big mistake. It’s about keeping it going, living to find another day, blah, blah, blah. That’s really what it’s all about, isn’t it?
It’s not, sure you can make more money if you take the trade that doesn’t fit the pattern by 1 pip, sure you can take more risk and maybe you just know this trade is going to work out so you take more risks.
I mean, that’s the kind of thing that if you read what he says, that’s kind of thing that George Soros does. He has these occasional trades where he’s absolutely convinced that he’s right and he’ll just bet everything that he’s right. It’s amazing to me that he’s still around.
I suppose you would argue and I’m guessing you would probably argue this too, Darren. This idea that for everyone George Soros, there’s a bunch of broke traders mumbling to themselves because they did the same thing George Soros did but George Soros was simply right when he had all his chips in. Yeah?
Darren: Yeah, definitely. We’re really going to discounting the people that have blew up. The strongest one person made billions of dollars then it’s really a good idea.
Walter: Yeah. Then, never mind that thousands that totally went broke doing the same thing.
Darren: I really think that this is why — with experienced traders — that, a certain amount of discretion is always more popular than being very systematic because I think if you have a little bit of discretion, it means that you can have a strategy controlling your risk.
But, that constant urge to I know a little bit better or this is, I’ve got a gut feeling that this is just a good set-up even though it doesn’t quite fit my rules. It kind of allows you to play on both sides to have it a bit of discretion there.
You can have a structured system that manages your risk and then every now and then you can express yourself a little bit if you like. I think that’s why discretion is so popular. The danger is when you have too much and then it completely blunts the risk control element.
Walter: Do you think that… I know you’ve talked about this in the past that if you have a real trading strategy that you could essentially write it as code. Not you, but someone that knows how to write codes.
I couldn’t do it either but someone who knows how to write computer code could code it up and then it would essentially do it, the computer would do the same thing. Do you think that, is that true?
Darren: Completely automated?
Walter: Yeah. In other words, it’s sort of like if we draw the line in the sand and say, “You have a true system” when your trading system can be coded and then completely automated. Do you think that’s true?
Darren: That’s a difficult question. Well, I suppose really, you’ve got to say yes to that really because if your system has an edge and the rules can be coded, then that should work.
I know Tom Basso did this with his strategy. He made them all automated and then all he does is look at the risk, basically. All the strategies that he’s got a work in a way completely on their own and then he just looks at how much is at risk at anytime and decides whether he needs to kind of stop adding to his risk.
Walter: It’s interesting because the people that are in the automated trading, like Mark Fletcher comes to mind in the forum, they talk about how it’s a different styles of work. People think that when you’re an automated trader, it’s just simply, “Yeah, I’m just drinking my pina colada and the trading robots just chuching chuching chuching. Just making money for me.”
But, he talks about how it’s a different, still work as a different style of work. It’s basically what you’ve just said. It’s about monitoring and making sure that everything is going and that the risk is okay and that you’re not outside your boundaries and that sort of thing, with all these things are churning away.
Darren: Yeah. And I think, maybe we kind of hold on this illusion that if we have some say in the decision making process that that must have an edge.
Darren: And maybe that’s just an illusion we hold on because it’s really comforting to believe that. If you lay out your strategy black and white and you get your results based on a backtest, maybe that is often not as comforting as we’d liked it to be. Maybe we’ll realize our strategy isn’t going to generate as much profit as we think.
We kind of stopped curve-fitting and say, “Well, I really use discretion here and stayed in that trade longer and I would have moved my break even quicker than there because of that.” Maybe that’s all just an illusion and maybe it’s just that that’s the comfort we need.
Walter: Yup, absolutely. I think that’s exactly why I believe so many traders, they like the discretionary approach. I also think that in the currency trading world, the scam robots have also given automated trading a sort of a bad name.
I think that’ll also probably influence, probably more in forex than in any market, other groups of traders. But, in forex traders in particular, I think because there have been so many automated robots that are sort of over optimized and had this great historical equity curves and then they completely collapse when you go forward with them.
I mean, that’ll also kind of gives it a bad name perhaps but I think it’s both of those things that are operating. I think that we feel like just like when we choose our own lotto numbers, we feel like we have something to do with it.
We also, like you say, when we go back on the charts and we let hindsight bias creep in we say, “Oh, we would have filtered out that loser.” “Oh, we could have filtered out that loser because of this and because of that.” It’s really easy, isn’t, it to do that?
I actually got an email, I think 3 or 4 days ago, from a trader who said, “Thank you so much for recommending forex tester because I’ve gone back and I’ve tested my strategy and it doesn’t make money.”
He had scrolled back on the charts and thought, “Oh, this is really good.” I encouraged him to get forex tester. Once he did that he said, “Oh wow, I’m really glad that I didn’t go forward with this because obviously there were some sort of hindsight bias that was making it look a lot better than it was.”
Darren: Yeah, definitely.
Walter: Yeah. Well, I mean that’s interesting. Just to sum up from my point of view and I think that trading strategies definitely restrict you in a way and can act as a boss but I think there’s a little bit more to it and it sounds like perhaps we might agree on that. What do you think, Darren?
Darren: Yeah, definitely. I like to see my strategy as the risk controller. It’s kind of my risk manager, if you like, and then whether I make money, it’s really determined by how the market moves and not necessarily that strategy. That’ll just stop me from losing everything.
Walter: Cool! Thanks for your time. We’ll see you on the next episode. See you, Darren.
Darren: Okay. Thanks, Walter.