When you make important decisions in life — do you decide by ticking off some self-made checklist? Or, do you go by your instinct?
In this episode of 2Traders Podcast, Darren and Walter tap into the subject of trading entries and exits, backtesting, market patterns, and how your trading results are the result of your psychology and mindset. According to Walter, a win rate is like a “median high tide line” that you should always consider when building a house near the shoreline. Darren believes that anticipating the market is more of an intuitive skill that you develop over time and experiences.
You will also see the connection between fiction reading and trading performance, and why women have a greater advantage over men in the trading world.
Download (Duration: 35:29 /40.6 MB)
In this episode:
00:51 – unique things
02:18 – odds and probabilities
03:11 – complexity and randomness
05:46 – newbie trader
07:56 – a false sense of confidence
09:06 – judgement calls
10:34 – pivot points
13:25 – human error
14:39 – simple options
16:02 – median high tide line
18:41 – scientific reading
20:04 – the “dead cat bounce”
22:18 – psychopathic personality
25:05 – algorithm
28:26 – all about the mindset
30:12 – what affects win rate?
33:43 – general rules
35:15 – system execution
Accept uncertainties rather than pretend to knowing the results. [Click To Tweet].
How do you avoid making the same mistakes? [Click To Tweet].
Past results are not indicative of future results. [Click To Tweet].
Walter: Is it fair to say… Would you say that you believe that the markets are all continually changing?
Darren: Yes, they look like they are not changing. If you have a random up and down movement then it is going to look like a chart…
Announcer: Two Traders, Darren and Walter, pull back the curtain on profitable trading systems, consistent money management, and profitable psychological triggers. Welcome to the Two Traders Podcast.
Walter: Welcome to the Two Traders Podcast. Walter here and Darren is on the line. Hello there, Darren.
Darren: Evening, Walter.
Walter: We are going to talk about the entries and the exits. This is something that has been niggling with me and I am hoping that this discussion will open it up because I know one of the unique things about the way that you trade and the way you view your markets is that you see how it is likely that when you take a trade, whether it is a buy or a sell, you have essentially a fifty-fifty chance of it working out.
Now, obviously that is going to differ depending on the exit strategy you use. My question is if we have a fifty-fifty likelihood of our trade working out for profit or for a loss, why is it then that our exits are not a fifty-fifty proposition?
I’d like for you to get into that because I know that you put a lot of effort in your exits, Darren, and I just want to dig into this. I think this is a fascinating topic, especially for traders out there like myself who are trying basically to get the perfect entry as part of our system.
I know that is not necessarily the cracks of the way that you trade. Can you unpack that for me? Talk about why it is or maybe it is not, why would the odds be different for the exit versus an entry.
Darren: It is more about having a different mind set about the odds of an entry and an exit. The usual approach is people decide how they would like to trade on what entry they want to take. Then they want to find out the odds and the probabilities that that entry will give them the outcome they desire.
I come at it from a different point of view and, really, I am saying however you enter, because of the complexity and randomness and lack in almost everything and human error, you cannot really workout the odds for that entry and it hold true.
What I am saying is let’s say that the outcome of every entry is random so, essentially, you are adopting a mindset that there is a fifty-fifty bet every time you trade. I am not backtesting and saying right, outcome will be fifty percent.
I am saying it is a coin toss. There is so much complexity and randomness that you cannot know what the outcome is going to be. Even if you test a period that’s past you’ve traded or just backtesting, that figure doesn’t really mean anything because all it represents is what happened in the past.
Minute differences in the future, even if the market conditions and players are the same, can give you a different outcome. Why try and spend your time getting a number to believe in if it is not going to hold water in the long run?
I am saying instead, accept that it is completely uncertain, that it is a coin toss and then look in other areas to make your money. For me, the big advantage in that is you cannot be disappointed in the outcome because you’ve accepted that it is completely uncertain and then you focus on the other areas of trading and your other techniques to make your money.
It is just a completely different mindset to how most people approach trading. What I am always trying to do is say, essentially, when we break trading down, it is a simple matter of buying and selling hoping to make more on our winning trades than we do in our losses.
Essentially, it is very simple. If it is very hard for the majority of people to do that, then I am saying maybe it is the mindset that they are coming with the techniques they are using and try to be profitable that occurs in the problem.
Walter: Because there is so much focus on the entry, usually what will happen — well, this is what most traders do, I know I did this — is you would look at a system and maybe not even backtest, maybe eyeball the chart and go “Yeah, I would’ve done… I think it would’ve worked”.
Maybe you trade it for a while, and it does not seem to work very well, you are in a drawdown or something. So, then what you do is you add more rules, more indicators, or filters to the entry because the thinking is I am just not getting in at the right spot on the chart, something is wrong here.
All that focus in the beginning as a newbie trader is on the entry. What you are saying is, really, your focus should really be on the exit. Is that fair to say?
Darren: Yes, yes, no. Really, I am saying just the whole way you think about trading and could possibly be wrong. You are coming at it with the wrong mindset to try and solve the problem.
It is like that story about where they would try to make like a jet, aren’t they? For some food processing, they’ve got all these amazing scientists in the computers and they were trying to design the perfect jet. They worked out what they needed to be and so they produced the jets and they never worked.
In the end what they did was that they just started it a simple nozzle, and they sprayed it through, and then they tweaked it and it improved then, they tweaked it a little bit more. They went down on a trial and error route rather than trying to be really scientific about it.
I just think in trading sometimes people are trying, looking in the wrong places to find the answers. I just try to be a contrarian and say this is what everyone is doing, that does not really seem to be working, how about we look at the opposite of what everyone is doing and come at it from a different point of view.
I enter into this whole cognitive bias on how we make decisions thing. I can see if you match that up to the beliefs of people have about trading, you can find that a pretty reasonable explanation of why people do or prefer to trade in certain ways.
Walter: Yes, right. One of the interesting thing that comes up here today is that this idea of the backtesting and how you can do this backtesting. You can get some numbers and that gives you perhaps, maybe you would say a false sense of confidence. Is that fair to say?
Darren: I would not say it is a false sense of confidence because you’ve got to believe in how are you going to trade. What you will need to do is to accept that your drawdown might be more than it was in the backtesting. Your win rate might be lower or higher than it was in the backtesting. It only gives you a feel of how it should perform in certain market conditions.
How it really performs when you trade comes down to the judgement calls that you make along the way. You are better to make judgement calls after you have this information of how your trade is working rather than trying to predetermine it based on what happened in the past.
For instance, when we come to exit rules, it is why I think that having a fixed exit is probably not the best way to go because you cannot react to the market. You are told that you have to follow your rules and stick to your system.
Whereas, you are much better to look at it as a judgement call and wait until you have the information or the event of your trade. The market has moved, now you can make a decision with context.
Walter: Is it fair to say, would you say that you believe that the markets are all continually changing?
Darren: Yes, they look like they are not changing. If you have a random up and down movement then it is going to look like a chart. Although, there are repeating patterns that appear to us visually, that is more because of how we look at the charts than anything.
For instance, we have the x scale which shows time. When we look at a forex chart, we’ve got the price on the y axis. If you remove that, the time element and just have the movement of price, then you wouldn’t make all this assumptions we do about what is significant.
Trend lines, support and resistance and patterns, candlestick patterns, I believe all of those are…Although, I am not saying that they cannot be used to trade profitably but I am saying that we perhaps overemphasize their importance because of the visual aspect of how we view the charts.
Walter: That is interesting because I’ve always thought the same thing about pivots. Essentially, what pivots are, you use pivot points that you were using the previous day to set the stage for today. That is how I see pivots.
I always thought that they are funny and I think they make sense in some situation but I guess, it is easier for me to look at pivots that way than it is for me to look at candlestick patterns. It is the same idea, isn’t it?
What you are saying… Because if you just take away the x axis, all you are saying is just up and down, up and down, right? That is all that you’re going to get if you are on a one dimensional chart.
Darren: Exactly. And then if you stretch that out over time, then it is going to make patterns that are visually appealing. If you go over a period of time on a chart and mark the candles with the best entry into any particular trade you will be taking at that time, that is the optimum entry and see if there is any distinctive pattern of all those best entry.
If I was going to use price action, I want to see those patterns, the majority of those key best entry and I do not just see randomized little candles, big candles, one with wicks, some without wicks. There is no recurring pattern there.
Why would I use that to enter my trades? I want to have the majority of my entries to be the best possible entries and so if I am going to do that, then I want price action to be at the majority of those points and I don’t see it.
Walter: That is a fair argument. I completely agree with that. However, what I would say, Darren, is you get the same result if you are looking at the charts. You are taking a sell trade every time the chart bends downward and a buy trade every time the chart bends upward.
Every time the charts bend downward, it is not necessarily going to go down for four hundred pips and when it bends upward, it is not necessarily going to go up for seven hundred pips. It is the same result, isn’t it?
Darren: It is. They key difference is the psychology behind it. It is the mindset behind it. I know that the outcome of my trade is purely down to the movement of the market. I am not expecting to be right. When I am wrong, I am not questioning my process and agonizing over whether I really should be changing my process and whether if that is right or wrong.
I am just accepting the uncertainty more rather than trying to say I am good at this, I know what I am doing, and I am going to be right. Then, when I am wrong, I go to that whole psychological issue and that brings in more human error to my trading. In the long run, that is what causes most of the trouble for people.
Walter: Absolutely, that makes perfect sense. Now, the question is how do you avoid making the same mistakes when you look back with the hindsight bias at your exit decisions? You are taking away, you are letting yourself off the hook on the entries but now, we have to decide to take profit or hedge or do whatever the decisions are in terms of getting out of those trades. How do you guard against that in terms of your exit?
Darren: You always are going to feel bad about your exits. It is something that I picked up from Denise Shaw that whenever you exit, you are going to feel bad about it. When it comes to exit, I have two or three options of what I can do when a certain event happened.
For me, the event will be price closing against the direction of my trades. If I am in a long trade and price closes down then, I will have like a few options to manage my trade like move my stop to breakeven and do nothing or take profit. Just simple options.
I accept that I am always going to feel bad because for one, I haven’t got out of the optimum because I waited for the price to retrace. Two, if I get out and price continues, I am also going to feel bad.
The way I deal with it, really, is by looking at my long term results and using that as the justification for how I am trading. If I only get a forty percent of the move because I picked the wrong exit, that is pretty bad.
If I am up in my yearly target then I am achieving my goals, anyways. It does not matter. I’ll look at the long term, at the bigger picture to deal with the disappointment of the individual trades.
Walter: Sure, that makes sense.
Darren: After a while, it becomes habit and second nature when you accept that majority of your trades, you could’ve picked the better exit. You just have to accept that.
Walter: You might look at your exits the same way that I look at, say, win rates. For example, you have an average or have a goal. Let’s say I did a backtesting on a system and I’ve found out that I have a fifty-five percent win rate. The win rate to me is like what we call the “median high tide line”.
What is the average high tide line?Because that is really important if you are going to build a home near the water. Because, one: you do not want the house to get destroyed by the storm in the high tide, king tides and things like that. The other thing is, it set the stage for you.
If you say “Look, I’ve done my backtesting. It looks like this is just fifty-five percent win rate”. Then, you go in and start trading it. On week one you are in and it looks like it has got a thirty percent win rate.
What do you do? You start thinking “should I freak out here?”or, “ just the market is a little bit different?”, “is it unlucky that I came in at this point with the system?” because later on, maybe you get out of that fifty-five percent level or around that level.
I wonder if that is the same way that you look at your exits because you say “Look, I have this goal to make this amount from exiting my trades. As long as I am achieving that or coming really close to that then I feel pretty good. It could be a little low tide, it could be a little bit high tide, it could be over my target for the year at this stage. It could be a little bit under it but I am having around that target and it is a good spot to be.”
I wonder if that is the same way that you look at it. Like for example, if you are at six months of the year and you have gone over your target, your pip target, for the first half of the year you’ve gone over that fifty percent mark. Do you freak out because you think you’re going to have a lot of loser for the last half of the year or do you pat yourself in the back? How do you view that?
Darren: I just view it as being a favorable market conditions and I am just being lucky with my exit calls. Also, if you spent a lot of time tradinG and watching charts, then you develop this empathy for the market. You develop the feel of when is perhaps better to stay in or get out and that is something that you cannot really measure.
I suppose you could struggle to prove whether it exist at all but I believe in that because we are trading against other humans. You cannot read the market. I know I always say that is not true. I think you can, in more of a sort of a feel, looking at your emotions and feeling that empathy with how the market is moving.
A lot of people try go down with a very scientific reading individual candles and elements like that. It is more of a intuitive thing that you picked up over time. Does that make sense?
Walter: There is a lot to that, Darren. I agree. I think that you can get to a point where you can get a feel and, again, I do not know if there is anyway to quantify this. I mean, I suppose you can look at sentiment or something like that but I think there is a certain point where, as a beginning trader, you might look at major fall.
Let’s say the EUR falls a lot. One day it falls five hundred pips, you might look at that and go “wow”. As a beginning trader you might think “Wow! It is going to come back to the middle of the Bollinger band. I’ve got to get ready to buy.”
Or, you might think as a beginner trader “Wow! That is a strong trend, I better jump on it”. But, as an experienced trader, if you’ve seen a lot of charts, you get this sense of whether or not this is a situation where the market feels like it is extended too far and so, there is going to be that normal pull back. Or, whether it is just going to be what they call “the dead cat bounce” where it just made a big move, it might come back a little bit, this is just gonna keep going and any kind of a pull back is just another reason to sell.
I believe in that. I think you can get to that point.
Darren: I strongly believe in it, as well. It’s like a confidence thing. It is a kind of confidence you want to develop rather than just the confidence that your backtesting gives you. I know that I am always negative about backtesting and I think it is really an important part of trading.
Again, people give too much emphasis to that alone rather than looking at, like you say, the feeling that you’ve built over time and experience. They did some research and they found that traders who read fiction were higher performing traders because they were more in tuned with being empathetic with other people like the characters in the book. Have you heard that? Have you read that research?
Walter: No. I haven’t heard of that study.
Darren: I do not know where I got it from.
Walter: It is fascinating.
Darren: I think it’s Denise Shull and she always brings up interesting stuff. It’s the best strategy to have no strategy at all and just get up in the morning and see how you feel.
That probably is the best strategy but knowing human biases and waking up feeling rough one day and you think you need some basic structure to just keep you, just to make those initial decisions a bit easier. The best strategy for trading is no strategy at all.
Walter: That is interesting. How would you interpret those data? That finding that says “Yeah, if you read fiction, you are more likely to be a higher performing trader”.
To me, that is interesting because the day the reports that I hear about, just sort of the major news, are things like the more psychopathic personalities are end up being the better traders or whatever so it goes against that a little bit.
I think it make sense because what I’ve noticed is that, I believe one of the advantages that women have in general in trading is that they are more likely to be in tuned of how they feel and like what you are saying, about reading fiction.
Maybe that means they are more on guard against doing something silly like taking that revenge trade or adding too much risk on this one because you had three losers last week or whatever it is.
Women are more guarded and men — I know I am generalizing — but men tend to be more ego-driven and they want to be correct. Whereas, women are much better in general, in personal relationship, and understanding how they are feeling and seeing where they at.
There is a lot to be said for taking stock. Where am I at today? How am I feeling today? Am I going to execute as I should or am I in a bad spot so I’ll just walk away and take a day off and not trade today?
These are the sort of things I think that women are much better at doing and possibly that it’s the hypertrader that they would be into reading a lot of fiction. I find that fascinating.
Darren: That mindset, as well, will reduce human error. With a lot of trading, if you could just reduce the mistakes you make — the human errors –that can be, over the long run, be the difference between the strategy that is breaking even and one that is making steady games every month. That is perhaps an advantage that female personalities might have.
Walter: The big thing is here is one thing that you can do as a trader and doing this one thing can completely change your bottom line which is just do not take the big loss. I mean, do not let the big loss come and take that huge bite out of your profits.
If you can do that one thing, and obviously that can come down to what you are talking about which is being aware of where you are at, making sure that you are not in that mindset where you are going to do something totally ridiculous and put your account at risk.
Those are the things that people who are self aware, they are not likely to make those mistakes. That is interesting. I do think that backtesting… To me, backtesting is one of the great tools for traders so I probably dig a little bit more on that side of things.
I know that you are not totally throwing it out but, to me, even if you do your backtesting and you say “I do not care that I’ve got a sixty-five percent win rate. I do not care about any of that stuff. I am not going to use that in my decision sizing, algorithm or whatever. You can throw that all away.”
Even if all that is useless data, I think that actively doing that trades and taking the trades and doing and being vigilant, there is a lot in that. That is valuable which is just a practice, basically.
Darren: I am with you, Walter. I am a hundred percent in that thing and I think backtesting is a brilliant tool. I just think with likelihood of it, a lot of things in trading, it is the mindset in that and how you use that data that is either going to make it a positive or a negative for your trading. You just have to see the data for what it is.
It is the data for a specific period and specific market conditions. It can give you an idea in those conditions of how your strategy will play out and how profitable it would be but at the same time, you have to take on board that might not be the case in the future. The uncertainty remains.
Walter: That is interesting. To me, that highlights your thinking in this sense because what you are saying is that the backtesting can really be valuable. It can be very helpful, it can be a tool that you can use to build your confidence.
At the same time, the markets are always changing and we do not know what is going to happen in the future. That is a sort of the standard disclaimer. Past results are not indicative of future results and that makes sense.
My point would be if you, as a trader, believe that the markets have done what they have always done and they will do what they always will do and goes through cycle, gets really quiet, gets really volatile, it goes up, it goes down, goes in a range, those sorts of things. If you believe that to be the case, that the markets aren’t dynamic and sort of sequential or in some ways always what they’ve been, then maybe you would be more likely to ascribe more value to your backtesting data.
If you are, I suppose, more on the side of where you at which is, basically, the markets are changing, they are very dynamic, then you have to be on guard that what you have in your data file there from your backtesting may not map onto what happens on the future. Is that a fair characterization?
Darren: Also, the unexpected happens more often than we think it does.
Walter: No doubt.
Darren: It happens a lot more often than we think it does. Again, it is just about how you react when you then go to trade live and your results are not in line with the backtest data and the conclusions you draw from that.
The conclusion should be that it is quite normal for your data to vary over short periods of time and then you need to look why there has been variants and then have to make a change on how you manage your risk or your positions or not. Accept that you need to give it a bit more time.
It is all about that mind set and whether you think that you can somehow control the outcome, or whether you are going to accept it to be wholly and certain, and at the same time feel that you have some edge in your technique.
Walter: That’s well said. I like that, that is good. One last question before we shut this episode, Darren, because I have to know what you think on this. When you take a system and you apply a strategy for exiting that system, for example — let’s take a concrete example — let’s say, I have a system where I flip a coin and in system A, I flip a coin, heads I buy and tails I sell. I am just going to try and get twenty-five pips.
Then, I’ve got another system. In my stop loss, might be like thirty pips, thirty-five pips away or something like that. I try to think it’s quick profit relative to my stop. In another system, I flip a coin I go heads, I buy and tails I sell.
In this case, I’ve got a hundred pips stop loss and I am trying to get a five hundred pips out of my trades. What would you say to that? I mean, would you expect it from win rate or how would you deal with that?
I guess what I am saying is, at a long winded way of asking, how does your exit strategy influence your win rate?
Darren: I think the longer you stay in the trade will influence your win rate and the farther your exit point is from your entry, the stop loss and the take profit will affect your win rate.
Walter: Essentially, if you really have a tight stop that is going to affect your win rate and if you really have a tight target or a really close target, that is going to affect your win rate. Right?
Darren: Right, exactly. That does not mean that sometimes that might be reversed if you get the particular market conditions but the longer you stay in the trade, the more opportunity there is for that trade to turn around and hit your stop. The more opportunity there is for that trade to go to a bigger target and that is logical.
Walter: By having a stop loss further away from your entry price, you are giving the trade more opportunity to keep moving toward your target or to make money for you, I guess.
Darren: Yes. In effect, you don’t really have to time the entry then because you could be getting in early and you get price room to go against you before it goes to your target or in your direction.
Walter: The extreme example of that would be hedge fund that uses, essentially, fundamental analysis to make their trading decisions and it is not really technical in any sense. In that case, these funds are taking trades and they are not really trying to time the entries at all.
They are more interested in making sure that they do not affect the market by placing all of their orders at the same time. They scale in, scale up, but it is not really about timing at all. It is more about just “Well, this is what we think is going to happen and so we are going to give in the trade.”
That is the extreme example of that and in the end it’s either they were right, they’ve made money, and they’re wrong. At some point, they hit the uncle point and they have to say “Okay, we were wrong. We have to pull out what money has left” or whatever. It is almost like they do not have stop loss or they do not have an entry strategy.
It is just that they have a general idea that this market is going to go down or this market is going to go up and, with their money, we sit around and we wait.
Darren: Essentially, the new information coming into the market is what makes the market move and decides where it goes. The assumption of what that information is going to be, as well, not just the actual information.
If everyone thinks that they are gonna pull up interest rates then it is not a surprise to see the dollar appreciating. Maybe that is really the best way to trade but, again, you are still trading on what the other traders think and believe.
They are just going to be people that try and speculate of knowing what you are going to do. If everyone is going to buy the dollar then people are going to be looking to be contrarian into that and stop people in going short.
It is not really my thing. It is the reason why I stay away from it. I am not very good at fundamental analysis and I haven’t really got the patience for it, either. It is something that is overlooked by a lot of traders for whatever reason. For me, it is as valid as using technical analysis.
Walter: To me, it just makes it easier to have general rules. I suppose you can still have general rules with your trading if you want it based on fundamentals. If they are raising interest rates, for so many whatever, or the job reports have been trending up or down or whatever, I am sure that you can do something like that if you really want to make it a rules-based system.
I think you are right. The big news to me, the big take of the fundamental, is what happens in regard to what is expected, basically. When the market is a surprise, that is when things are really get shuffled around a bit. When the market is isn’t surprised and everything shakes out the way it is expected, that is when things are in status quo and they keep going up, or keep going down, or whatever they are doing before. The surprise is the one that kicks them in the pants and changes the direction or whatever.
Well, Darren, do you have anything else you want to add about entries and exit? I know we’ve touched on different aspects of this. I think we’ve done a really interesting conversation. I am looking forward to the next one. Do you have anything you want to leave the listeners with?
Darren: Just like always, examine your mindset and just question your beliefs and perhaps just try and see things from a different point of view, not necessarily change what you are doing but just consider it.
Walter: That is a good advice. I cannot wait until next time and we will talk about system executions. That should be interesting.
Darren: Cool. Cheers, Walter!