What should you do when you think it is time to change your trading system? Is it ever more profitable to change (or bend) the rules? Walter and Darren dig into strategies you can use for maintaining consistency with your trading system.
Download (Duration: 22:23 / 20.5 MB)
In this episode:
02:10 – what’s really going to happen with your system
02:39 – your most important trading system questions
03:51 – the view from Mt. Everest
05:03 – why some traders don’t “pull the trigger”
05:30 – a trick for vetting your trading system
07:33 – trading is so “easy” (or is it?)
09:37 – the surprising way to avoid “knee jerk” mistakes
10:45 – the weird trick that winning traders use
12:00 – how to think about “trading work”
12:31 – getting paid per decision
13:09 – the recency bias in trading
14:51 – intelligence won’t make you money
15:36 – what traders flock to, and why
17:30 – how to reduce poor trading decisions
Walter: One of the big mistakes that we make as traders is that we highlight what happened last time, so the last trade, or the last couple of trades, if there’s some sort of theme going on that …
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
Walter: Hey there, it’s Walter Peters, and you’re here at the Two Traders Podcast. I’ve got Darren with me on the line. Hi Darren.
Darren: Hello, Walter.
Walter: We’re going to be talking about this idea of bending the rules. Why is it that some traders, or many traders, in fact I’ve been one of them, want to bend the rules instead of just sticking with their trading system? You’ve got a trading system, you’re pretty convinced that it’s going to make money for you, so why don’t we just execute it, Darren? What is it about traders where we want to bend the rules or change the system, and not really stick to what we believe is going to do well for us?
Darren: Simply, I think, Walter, we’re not built for trading, firstly. We’re not built to deal with uncertainty. We want to remove uncertainty in everything we do. We want guarantees. You have to do certain things to be able to counteract that, and the one I know the most with traders is … someone spoke to me the other day, and they said … I’d explained a training system to them, and they said, “Okay, I’m going to start trading this and practice so I can get good at taking the entries.” I said, “Well, you’re going to learn anything by doing that, because you haven’t prepared your mindset to trade the system. You just know the rules of the system, but nowhere have you got written down what to expect.”
When the system plays out in real-time, something’s going to happen that you won’t expect. Although it is most likely parcel of the system, and then you’re going to react that emotionally, and make a bad decision. I think one of the most important things, like when you do back testing, people think back testing is to find out if it makes a profit or not. That’s all that matters. They did a back test, and say, “Oh, yeah, it made 10,000 pips last year, brilliant, so I’ll just start trading it live.” Whereas really what you need to do, and when you back test is say, “How long is it before it’s profitable? How long are the periods that it doesn’t make profit? How big are the draw downs that I’m going to experience?” All of these figures are just ballpark figures, but you need to write those down so you have realistic expectations of what’s going to happen. Whether it makes profit or not is like the end of the equation, the least important bit to find out, because that’s not going to affect your decision making at the end of the day.
I think one of the main reasons are people don’t have realistic expectations, and they haven’t made a note of that when they’re doing their back testing, so when the system plays out as it should, they get surprised, they get emotional reaction to a negative aspect like losing, or run of losers, and then they make changes to their systems. That’s one of the most important for me.
Walter: That’s interesting. What if I were to say to you, Darren, that I think I really want to climb Mount Everest, and the reason why I want to climb Mount Everest is I think the view will be amazing when I get up there, and I just can’t wait to see that view. It’s sort of the same idea, isn’t it? Where we put all this focus on the end result and not what it takes to get there, right?
Darren: Yeah, and I think it’s important like you say to have that goal, like you say. You have a goal to climb Mount Everest, but you need to know all of the bit in between.
Walter: Exactly right, yeah. I think that’s a great way to see it, because as you say, you don’t necessarily feel the draw downs when you’re back testing 5 years worth of data, whether you’re doing it bar by bar or letting the computer run it for you, you don’t really feel that. Just because over the last 15 years the deepest draw down was 11%, that doesn’t mean that you won’t see a 25% draw down in the future. These can be seductive and tricky and I agree with you, most traders that I’ve spoken to, they usually are focused on the … Now there’s a few exceptions, but they’re usually focused on the profits, on the end result, and usually the traders who focus on the draw downs and the negative, those are the ones that have a more difficult time pulling the trigger, if that’s their main focus is on the loss.
Here’s what I think. I think that one way to get around this is to trade a little tiny account with a little bit of money. Let’s say if I’ve got 80,000 pound to trade as my trading money set aside, I might only trade 1,000 pounds with my little mini account. What this will do, a couple of things. It’ll show me how long it takes for my trade to reach profit, and so I’ll see what this is all about. I won’t be going through the full stress and strain of trading my entire account, however tempting that might be, and I also will be able to experience draw downs with real money. If you’re demo trading, or back testing, you don’t really feel the pain of real money. Even a small account, it doesn’t feel good when you go through those draw down. I think that for traders out there who are concerned about this issue, people who are worried that I’m not going to stick to my system, one way to possibly prepare yourself is to trade a mini account.
Trade a tiny account. Does that mean you won’t bend the rules in the future? No I don’t think that guarantees that, but I try and focus on if I want to tweak things, or change things, or bend the rules, what I try and do is put that through a process, so the process of basically vetting a system. That would be it goes from and idea, to something that’s back tested in forex tester, to forward tested, and then to a mini account. I have to put it through these hoops. Not really because I’m concerned about the system. Most of the systems, most of the ideas I come up with fall flat, but if I want to get good at trading that system, I feel like I need to become intimate with it, and understand what it’s going to do in different market conditions. I agree with what you’re saying, it’s an interesting point that just because you know the system doesn’t mean you will be able to trade it.
The reason that’s true is because you haven’t really grasped the psychology of what it’s going to be like to be trading that system in the live markets. I think it’s a really interesting point, so I guess if I were to ask you, let’s say I was someone who said, “Okay Darren, well what do I do, then? How do I prepare myself to get to that point where psychologically I’m going to have what it takes to stick with this?”
Darren: Well, a couple of things have been proven to help traders, and that is also we as traders, we find the fact that trading appears to be less work than generally what we’ve done to earn our income before. A lot of us get into it because we’ve got a bit of a hankering to be lazy, really. It’s like, “Oh I get up, put on a few trades, go on holiday, make a couple of grand. Buy a new car, I’ll put a few more trades on.” I think we’re all naturally drawn to that, because it’s very appealing, and I think we don’t appreciate how much extra work you need to do to be able to trade a strategy. What’s been proven to make a difference is making notes. This is notes about like I was saying before, what the expectations of your systems are, what was the biggest draw down in the last year, what was the average … Make these notes so you’ve got realistic expectations. Then make some notes about what you’re going to do when you’re actually in the process of trading.
Then you need to make notes about what you’re going to do when you finish trading, and you’ve taken profit or you’ve taken a loss. Or, if the market condition changes, what criteria are you going to accept to make a change to your strategy? You’re allowed to change your strategy, but you need to be doing it based on data and not on emotions. If the market conditions changed and you’ve found that perhaps you’d be better off using a slightly wider stop, you’re doing that because of all these notes you’ve made and the data is telling you that, not just because you’ve had a bad week and you’ve lost a lot of money, so you just want to change it because you feel bad about yourself. You’ve got to accept that the market is going to do that to you, and again that goes back to the expectations thing. They did some tests on some traders in London.
They found that if they had to write down reasons they were making a change before they were allowed to change their system, then usually by the time they’d finished writing it down, they’d have time to digest what went on and they’re feelings, and they’d perhaps calmed down from the fact they’d had a bad day and realized, “Okay, it was actually just a bad day and I don’t need to change anything.” Really you’ve got to really get this deeper connection with yourself and understand that you’re going to have these emotional reactions to trading. Emotion’s going to play a massive part in your trading and sway your decisions greatly. Unless you’ve got some way of disciplining yourself, unless there’s going to be a manager stood behind you saying, “What are you doing? Why did you change the strategy?” If you haven’t got that, then you need to write it down.
Nowadays, we don’t like writing down. We text, and we type on keyboards. We don’t like the actual physical activity of writing down. It just slows things down, and gives you a time, gives you a chance to quantify what you’re feeling and make a better decision. That’s how I see it, and it’s a fairly simple thing, but a lot of us don’t want to do it because we’re a bit lazy. We just want to get up and sit and the computer and start trading. I think the traders really do well, haven’t got a particularly brilliant strategy, they just work harder at the bits that make a difference.
Walter: Yeah that’s a great point. The idea of writing it down reminds me on the data of people who have gone through a dramatic life event. It’s the same sort of data they’ve found that if you go through something really severe in your life, those people actually process the event and do things like journaling, write it down, and talk about it. They were the ones that were able to basically move beyond it, whereas families and people who would just not talk about it, and it was a taboo topic and it was off limits, those were the ones that had difficulty. It’s really interesting, this idea of journaling or writing down, how it can help with clarity, and it can help with processing this idea, this thing. That makes a lot of sense to me. The other thing that you brought up which was interesting to me was the idea that we’re essentially lazy. I think that there’s great nobility in this idea that you’re going to have your money work for you, because most people don’t think that way, right?
They think that I’m going to work for money, so once you make that switch in your mind and have your money work for you, which is essentially what trading is, I think that’s a good thing to do. However I agree with what I believe your main point is, is that look, a lot of us, what we’re trying to do here is we’re trying to free up time. Right? In the end, that’s what a lot of traders are after, because instead of trading time for money, they can trade money for decisions. I make a decision about the markets, I put my decision into my computer, and then I either get paid, or I have to pay for the wrong decision. Essentially it’s kind of a way to get away from being locked into a job or something, some situation where you actually have to trade your time for money. For a lot of traders, it’s worth it to aspire to that, and I think that’s great, but I also think that one of the big mistakes, and today’s topic kind of touches on it, one of the big mistakes that we make as traders is that we highlight what happened last time.
The last trade, or the last couple trades, if there’s some sort of theme going on there that we can see, and we’re very good at seeing patterns as humans, so there’s usually not much of a problem there, then we’re likely to come up with a reason why we should adjust. The last 3 trades, my stop loss was hit very quickly, so I need to widen my stop. Or yesterday’s trade, what happened was it went really close to my target but then it moved away too quickly, so I need to make my target closer on the next trade. These things, to me they’re mistakes that we make because we’re trading the last trade. Would you agree with that? It’s something that I think it just happens too often, where it’s like an exponential moving average. An exponential moving average weights more heavily the most recent price than it does the price 10, 20, 30 days ago, or 30 hours ago, or whatever time frame you’re looking at.
That exponential moving average puts a lot of weight on the most recent move. That’s why they move a little bit faster than a simple moving average, but I think we humans use the exponential way of thinking, where we put more value on recent events, and we tend to adapt based on what happened recently, rather than the big picture.
Darren: Yeah, I agree with you Walter, definitely. Again, we’re making a impulse decision in the moment. Once you know that this is natural for human beings to do this, once you decided that your thought processes and your emotions are important in trading, then it’s really easy to counteract that. As long as you’re holding the belief that just your pure intelligence and skill and ability alone is going to be enough to see you through, then you’re in trouble. This has been proven time and time again now that the traders that are most successful are completely in touch with their feelings, and they can express how they’re feeling, and how they’re feeling when they lose, and how they feel when they win. These traders are the most successful. I think as long as your discounting the importance of your emotions in your trade and while you’re trying to suppress them, then you’re going to have difficulty because you’re going to react to your feelings in the moment, and that’s when people change their system.
The other one is when they hear someone else is doing well. People instantly want to flock to it. Something new that everyone else is interested in, and you just cannot resist it. Again, it’s just the natural human reaction and urge. If you’ve had a bad week and everyone’s writing on this thread, “Oh this is brilliant, oh I love it. Brilliant, oh I love your ideas,” And you just instantly flood there. You went, “Well this is the answer.” Again, it’s being lazy, because you just want to find an easy quick solution to the pain that you’re feeling because of your bad week. Again, it nearly all comes down to emotions. Put a figure on it, say 70% emotions and 30% strategy, if you want to quantify it. If I had to guess a figure I’d put it in that ballpark, rather than 70% strategy, 30% emotions. That’s how I feel about it.
Walter: What are your recommendations? If you’ve identified this as a possible problem, or an issue in your trading, how do you avoid changing the rules and continually going back and changing it up? What do you do as a trader?
Darren: I think really simple steps. The first one is go back to your strategy and redo your back testing. This time when you do your back testing, make some notes about the realistic expectations. You don’t have to be precisely quantified, but have some idea of what’s normal and normal market conditions, and write that down, so you have some expectations of what’s going to happen. Something you can refer to. It’s just going to save you that 25% of mistaken decisions. If you can just reduce a little bit of bad decisions along the way, it can make all the difference to your trading. The second one is to define, like you say, climbing Everest, define a goal. Most people don’t know what they’re trying to achieve by their trading, so define some goals and work back from there, what you want to achieve long term, or what you want to achieve in the next year, or the next 6 months. Define some goals.
Then the last one is, and I’ve probably mentioned it in every Podcast we’ve done, have a look at yourself, and your emotions, and study about how humans react to emotions, and learn to get in touch with them so you know that when you’re doing something in your trading, any aspect of your trading, that you put this extra step in between having a feeling and making a decision where you say, “Okay, I’m going to make this decision here, what am I basing it on? Is this a good idea, or is it just me reacting?” Get in touch with that, learn about it. There’s loads of stuff on YouTube. Find out what you like and what you don’t like, and don’t find that out by trading. Find that out by just go out with your mates for the night, and when you have some emotional reactions to things, work out what’s happening. What exactly is it? Are you feeling fear, or joy, or excited, and what’s causing that in you? You’ll find a little bit out about yourself. I found out recently when I went on holiday that I don’t like winning… and I never knew that before.
It’s only because I’m aware of my feelings now, that I’m looking out for these little telltale signs. I was in a bar full of those people with one pool table and everyone was watching, and I lost a few games and that felt shit. I really didn’t like that. Then I won a few games, and I had exactly the same feeling. I didn’t associate them as being the same feeling before, because I’ve never even been aware of my feelings and what’s going on. I thought, “Well that’s really strange, I never knew that about myself.” Then I can refer back to my trading, I can see where I’ve made mistakes in past, both when I’ve had losing days and when I’ve had winning days. Yeah, look at yourself outside of the trading. I think just those 3 things really just make a massive difference.
Walter: Great point. The only thing I would add to the feelings thing is, and interesting technique to use is to see yourself, so you think of viewing yourself as a bystander. Let’s say that you’re getting very upset from a particular trade or something like that. Just step outside and think, “What would it be like if I were watching myself right now?” That’s one way to step outside of it. Another thing you might do is meditate. Meditation, or self hypnosis, or whatever you call it, that’s another way for us to really slow down. Like you say, we live in a life of texting, and there’s a lot of information around us. We don’t necessarily have time, or we don’t really have the okay. It’s not approved for us to actually just slow down and do nothing, which is essentially what you do when you turn inward like that. That’s another thing to do.
The last thing I would say is probably before you get to a point where you’re trading a system, have a system for vetting that system, so pushing it through a bunch of hoops at the very least, so that you’re not making these fly by the seat of your pants changes to your systems based on what happened this week. That’s another thing I would definitely strongly consider, but I think your idea of journalling, or writing down stuff, can also really help you in terms of making sure that what you do is not something that’s a rash decision, it’s something that it’s actually thought out. I think that’s a really good tip as well. I really appreciate this Darren, this has been a good one.
Darren: Yeah, I’ve really enjoyed this Podcast thing. This is stuff that’s really close to my heart, and it’s been a big part of my trading most recently really. I’ve personally made most improvements in my trading with these kind of things. It really can make a difference and improve your results.
Walter: Great, great. Well we’ll see you next time, Darren. Take care.