Archive for the ‘Psychology’ Category

Trading shibboleths are acid on the brain

August 6, 2009

It’s virtually impossible to have a meaningful discussion about trading with someone whose contribution is proudly limited to spewing trading shibboleths. Their account never suffers a loser because of their faithfulness to petty phrases such as ‘the trend is your friend’ or ‘trade what you see, not what you feel’ or ‘keep your losers small and let your winners run.’ Shibboleths are popular phrases that have become devoid of meaning. Those who repeat them are revealing themselves for who they are.

What does ‘the trend is your friend’ actually mean anyway? (donning my Andy Rooney hat) Jesse Livermore planted that phrase into the minds of traders as a means of gaining an edge over them. Get them babbling about cute phrases that rhyme and take their money in the interim. They’ll be content to watch their accounts dwindle as long as they have some shibboleth to grab hold of to explain the recent depreciation. Whenever they have a winner, program them to say ‘I let my winner run.’ And whenever they have a loser, program them to say ‘I should have kept my losers small.’ That way, instead of them thinking about what they’re actually doing, they’ll be thinking about applying the most appropriate shibboleth as the situation demands. Confusion in your adversary is key.

Do you ever notice how dumb you feel when you repeat some retarded trading shibboleth? That is by sinister design. It’s psychological warfare out there and the dirty little secret is that other traders constantly try to gain an edge over you. When you feel dumb, you’re likely to act dumb.

Next time you have the urge to spout meaningless dribble, resist. Don’t even try inverting a popular phase, such as cleverly stating ‘the trend is not always your friend’. You’re wasting your time and brain cells. Think about what you should be doing instead of what phrase you should be repeating.

Now go grab the bull by the horns and get trading. Or something like that.


I’ve filed for a divorce

August 4, 2009

I think, and hope, that we can still be friends, but my days of being married to high-probability discretionary trading are over. This separation is amicable and mutually agreed upon. We had a good run, but things ran into trouble last year when the market gave us something we’ve never seen before. Our relationship has never been the same since. The screaming, the accusations … oh, it got ugly. I thought maybe we could work it out this year, but this latest 3-week rally has put a permanent end to our relationship.

High-probability discretionary trading is the mistress or spouse of many traders. She is seductive, beautiful and addictive (lady traders, feel free to visualize her as a him, if you’d like). She promises, and oftentimes delivers, low risk for high reward. There is nothing so alluring as visualizing a setup that has a defined risk (the place where the trade no longer works) and its potential reward, which can be five times larger or more than the risk.

High-probability discretionary trading’s father is Poker. He taught her growing up that it’s all about betting based on the size of the pot and your individual odds. He taught her that you don’t need to play every hand, and sometimes it even makes sense to fold a good hand to get an idea of how others are playing.

Where my relationship with high-probability discretionary trading went bad was in my expecting something from her that she could never deliver. Probabilities that were actually based on reality. You see, her probabilities are a little problematic, and she will be the first to admit it. I know there are many successful traders out there who are still very happily married to high-probability trading, and maybe things would have been different with me if I had just listened more. Who knows. It is what it is.

Even though I’ve had relationships with fundamental trading, intuitive trading and emotional trading, I found high-probability trading worth getting married to. Now that I’m moving on, I’d like to introduce you to my future spouse: system trading.

I know she’s kinda boring compared to the others, but I love her for that. She’s a little frumpy, awkward in public and can’t play sports, but she’s a bit more real to me the than the flashy others.

System trading takes a notion or idea and puts it through a scientific process of validation. It includes backtesting, optimization and walk forwards. It involves compiling a statistical profile for a trade system and the market to be traded. When she fires off a signal, you take it. No discretion. All the work you’ve done on understanding the system depends on you taking every signal. It’s a very committed relationship that way.

If all you like to talk about is the latest reality show and what your neighbor is selling his house for, then you probably won’t like system trading. If you like Wittgenstein, Tolstoy and Gabriel Garcia Marquez, then you may have found your mate. We talk about things like intermarket correlation, genetic algorithms, neural networks, particle swarm optimization and fuzzy logic over breakfast. It’s fun, but then that’s me.

You don’t need to follow trading rules

August 3, 2009

We’ve all heard the proselytizers of trade planning bemoan lesser traders that they need to follow their trade rules. Yet, emotional traders still dominate the retail trading landscape. After hearing about how bad they are for acting as they do, they flagellate themselves for allowing emotion to enter into their trading decisions and re-dedicate themselves to discipline trading without emotions. But who are we to judge why and how someone else trades with their money?

Of all the different types of trading styles, I find the emotional style of trading the most entertaining. It is more human and natural than a game of probability. There is personal stuff at stake. Anyone who preaches to you that you need to stop it and get a plan is really preaching to themselves. They are healing a wound, or trying to convince themselves that they no longer participate in the egregious activity of trading without one. They are essentially scared of their emotions.

You cannot detach yourself from your emotions. If you want to trade based on emotions, I support your decision. After all, it’s your money and it’s not my place to tell you what to do with it.

Rules. We think of them as ‘made to be broken’ for a good reason. Rules are limiting and suffocating. Yes, we need some basic ones in our lives, but as soon as a method of trading is defined as a rule, the inner workings of the imagination begins the task of find ways around it. It’s only natural. Our total human experience cannot be contained with stupid rules. And who is making these rules anyway? Why are they valid? We all know that rules are put in place because we basically don’t trust someone (maybe ourselves) to do the right thing when the time comes.

Rules are really a false sense of security. Your contrary imagination will find a way around them, as water finds its way around rocks. It takes more than rules to prevent yourself from being stupid.

You don’t stick your hand in a fire because you’re following a rule that one should never stick their hand in a direct flame, but rather you’re resisting the urge because you have some common sense and an underlying urge towards self-preservation.

Become comfortable with yourself. And if you are recovering from the horror of losing large sums of money due to your own compulsive behavior, please don’t preach to the rest of us about how much we need to follow rules.

If you should decide to employ trading rules, have it be because you choose to make your trading simpler, not because someone told you that you need them.

One last drag, and then I’ll quit

April 29, 2009

I’m not a cigarette smoker, but I must be smoking something. I announce the suspension of discretionary trading (on a temporary basis), and all I do is discretionary trades. My latest transgression is a quick 3-day trade. I’m in, I’m out. Small profit.

Here’s the play. We’re all gonna die because of yet another natural disaster. This time it a pig flu or something. Whatever. SARS, bird flu, warming, cooling, pandemic over here and polar bears dying over there. I know when I’m being played.

So the latest trade is to buy drug companies (read: the hero of the fable) that will save us from the latest nefarious villain to assault the good people of Planet Earth. Alright, I think I’ve seen this episode before. If not, it looks very familiar. Hmmmm. Anyways, what comes up on the recommended buy screen is NVAX, a drug company, presumably. What do they do? Not sure. And neither do the herd buying this, pardon the expression, pig. A stock stuck in the doldrums of pennydom all of sudden is the hot pick of the day. Well, I see volatility spike to 257% in JUN and the 5 call is selling for $0.75. Okay, I’ll sell that. I’m taking on unlimited risk to make a measly few cents, but I’ve already disclosed I’m smoking something that is probably not good for me.

The trade goes my way on day one, up $0.40. Day two it goes against me as the stock rallies into the close, but still up net $0.20. Day three comes and this flu scare still has legs. The government is talking about spending (big surprise there) some serious money to control this problem.

Now I’m getting nervous. What does NVRX do again? Quick Google search reveals they’re working on a vaccine. Uh-oh. It’s time to bail. Put in a bid to buy back my short call for $0.35. Market moves my way in the morning and I’m happily filled. Net profit of $0.40.

Now I’m back to suspending discretionary trading on a temporary basis. At least until the next time. And I’m not counting the FAS/FAZ anti-pair covered call trade, which I still have on. It’s complicated, okay.

Discretionary trading unsuspended (temporarily)

April 29, 2009

Okay, I know I’m going down the road of system trading and I’ve suspended discretionary trading (on a temporary basis), but sometimes a trade looks like it can’t lose.

At least that’s what I thought with a seemingly brilliant hedged pair: long equal shares of FAS and FAZ. All one needs to make this trade work is to buy them when they’re trading near the same price and pray for one of them to breakout. The basic idea is that if they move in equal percentage moves, the one that moves higher will compound itself while the laggard slows its Zeno-like approach to zero. Instead of the traditional pairs trade where one bets on a reversion to the mean, and for high flyer and low rider to get back together, this one relies on the opposite to happen. A divergence of the underlyings makes this a winner. It’s sort of an anti-pairs trade.

So I bought FAZ at $12.00 and FAS at $6.20. Not exactly near the same price, but why get picky here. Wouldn’t you know it that the two devils decided on a rendezvous at around $8.40. That’s a $3.60 loss on FAZ offset by a $2.20 gain in FAS, for a net loss of $1.40. Okay, it’s a rough start. But this is as bad a loss as one can expect, right? After all, if FAZ continues to drop, FAS will continue to rise and before you know it the trade will be back to break-even.

But someone must have figured out what I was trying to do and decided to let these two languish near each other, which is the absolute worse thing that could happen. And to make matters worse, it appears that both FAS and FAZ have some sort of price decay built in because I seem to recall they met around $9.00 just a couple weeks ago.

What does one do with long stock that isn’t moving. Well it seems the only sensible thing to do is sell call options against it, just outside the money at a place that is affectionately called ‘junk’ by premium sellers. So that’s what I did. I sold the MAY 10 call in FAZ for $1.10 and the MAY 10 call in FAS for $0.61. The grand total is $1.71.

Now the worst thing that can happen is for FAS or FAZ to breakout. Depending on which one did it, I would either lock in a loss of $0.29 (FAZ) or realize a gain of $5.51 (FAS). Mind you that accounts for only half the trade. Where the tanking stock settles determines the trade’s total PnL.

The next time I take this trade is when both FAS and FAZ are trading within dimes of each other. Then buy both and sell OTM calls on both. Basically, you get double the premium on the covered call because only one can go up at a time. You still have the risk of the selloff victim, but does anyone really see either one going to zero?

Discretionary trading takes a back seat

April 19, 2009

I am suspending (on a temporary basis) my discretionary trading. It doesn’t take much to gather that I’m not making a lot of money doing it, otherwise I wouldn’t be suspending it.

For the record, I’m not suspending discretionary trading because I blew out an account. But I did see a 20% return dwindle to about 5% for the year. Still profitable, but that’s a hell of a lot of work for 5%.

Discretionary trading is an art form. There are some wildly successful discretionary traders throughout history and no doubt among the living today. In fact, you may be part of this elite group. I’m not. At least not now or in the foreseeable future. So as a result, I hereby announce myself as mostly a system trader. I’ll throw a discretionary trade out there every now and then, but they will be small trades.

My pursuit of system trading will include the following liquid, leveraged trading vehicles: options, futures and currency pairs. They will be strategies that have defined entries, exits, stop-losses and money management or position sizing. There will be a logic behind each system that seeks to take advantage of market behavior. These systems will not express an opinion, as must be the case with discretionary trades, about near-term market direction or lack of direction. Instead, they will express a sort of meta-opinion on how markets work and what patterns they display. The only claim these systems have is positive expectancy over a statistically valid series of trades. In other words, there is no expectation that the next trade will be a loser or a winner, just that after 100 trades, the equity curve will rise.

Discretionary trades are different from system trades in that they do have the expectation that the next trade will be a winner. If it’s not, there are various ways of dealing with it on a psychological level, but overall it’s a disappointment.

Discretionary trades are quite a bit more exciting that systems trades and require the mastery of a much wider range of skills. System trades require statistical research and testing and are relatively boring, unless you consider a rising equity curve exciting.

My research into systems trading is going into three main areas. First on the agenda is Trend Following Breakouts. This is easy to program and backtest because triggers for entry and exit are normally some technical indicator whose mathematical equivalent is simple to code.

Second on the list is Market-Neutral Option Spreads. This includes your plain vanilla Iron Condors and the like, but there are two ways to put them on. First, you can use a rage of criteria such as 28-44 days out and decide if you should even put one on this month. This is discretionary. A system-based approach will always put the trade on month in and out, and at the time with the same risk parameters. That is the only way to backtest, optimize and walk-forward an approach.

Third on my list is a non-reversion Futures Pairs strategy. This one is a bit more esoteric and its triggering mechanism is not easily defined. It sells the dog and rides the pony, and has no expectation that there will be a reversion to the mean.

So basically I have two trend-following concepts and one mean-reversion concept on the board.

More to follow.

Welcome to Milk Trader

January 28, 2009

Milk traders, welcome!

How do you know you’ve reached the right blog?

–You know you’re a milk trader if you control a micro account.

If you control more than $10,000 in a trading account, may I recommend you listen to CNBC for trade ideas. When your account dips below $10,000, then please come back. When milk traders reach a 10% profit or more, money comes out of the account.

–Milk traders do not trade stocks.

Why? Because there is no leverage in stocks. And since we control micro accounts, we need all the leverage we can get. So what do we trade? Liquid markets in futures, forex and options where capital outlays are less restrictive and leverage is 50 to 100 times.

–Milk traders are skeptical of smart money.

We believe Cramer is a blowhard and Warren Buffett is an historical anomaly. We couldn’t care less what EBITDA stands for. Instead, we use statistical and technical analysis to put ourselves on the high probability side of a trade.

–Milk traders NEVER random trade.

There are two good reasons for this: a) we can’t afford to, and b) random trading is for dumbasses, and we don’t want to be dumbasses.

–Milk trading focuses on four major markets.

Our focus markets include stock indices, commodities, foreign currency and treasuries. Within these major markets, there is a plethora of futures, currency pairs, ETFs and cash-settled options. And plenty of trade ideas.

Enjoy, there’s more to come.

…and I shall lead you to a land flowing with milk and money.