Long & Wrong

For once it is a figure that I didn’t record, but I guesstimate it took well over a thousand hours for me to get to break-even with my trading.  That’s not surprising because we all know how tough trading is don’t we? But a quick look at the numbers, unencumbered by emotions or preconceived ideas, suggests that it shouldn’t be.

Lets assume we are not going to try our hand, and blood-shot eyes, at scalping a few point here and there. So even if we trade intra-day it is a reasonable assumption that our average profit or loss is a decent sized multiple of  the spread (I suppose I am also assuming that we are not going to be trading something like GBP/HUF!).  We can’t ignore the spread but, as this is just the back of an envelope, that’s exactly what we’ll do.

So with a reward to risk ratio (R:R) of 1:1 we only need to get the direction right as often as we get the direction wrong.  Tossing a coin should be a break-even strategy.

Even if we allow for the spread, and say we make N trades a week, our weekly loss should be no greater than (N x spread) if we just followed this random approach. Any greater loss means we are actually worse than random, this takes some skill, it just happens to be the wrong sort!

So what is interesting is why it isn’t this easy, it’s not.  Understanding why is a way to learn some lessons (as was those thousand hours).  Now this blog has got way too ‘preachy’ recently so I’m not going to bombard you with my list (Number 1 is ‘Money Management’, oops, couldn’t help myself).

Just a short post, you can file it under ‘little gem of wisdom’,  ‘stating the bloody obvious’ or somewhere in-between.

A recent report in the UK suggested that we are producing a generation of narcissistic kids. Parents and schools are praising them too much and are afraid to ever tell a child that they are wrong. They grow up with egos that no longer fit in the room.

Thankfully my readership is, as far as I can tell, over the age of 18 so I will not harm you by suggesting you may not be wrong as often as you think.

This blog used to be about trading and now he is talking about kids.

I have noticed a tendency for traders, especially beginners, to talk about trades that were wrong (they even inspired the name of this blog, although not as much as my love of rhyme did).  They post their charts on forums and ask “what  did I do wrong with this trade?”.  Well here is one of my trades, but it was never wrong, it just lost…

I sold the FTSE Future at 3810 with a stop at 3820 and a target of 3770.  Just a few minutes later, as the resistance failed to hold,  I had lost 10 points. So was I wrong?

My ratio of reward to risk was (3810-3770):(3820-3810) or 4:1. †¹

So if the probability of this trade winning was greater than 20% (1/(4+1)) then it was theoretically the right trade to take.  If I made the trade 5 times and risked £80 each time I would lose £80 on four occasions and win (4 x £80) once. I would therefore break-even at this probability and make money if it was any greater than 20%.

So a trade isn’t wrong unless your estimate of the probabilities is wrong. If it is that means your strategy is wrong. So by all means punish yourself for a bad strategy, but not for losing trades that were never wrong -  they were right but they lost.

†¹ I know I have ignored spread, but I made the numbers up anyway!

I was naive enough when I started trading to think that if I sat here for 10 hours a day then I would make money. I didn’t expect to become a great trader overnight but I did expect a return for my effort.  Perhaps this idea comes from my working class background, you may not get paid much, but if you work then you earn money.  In the UK there is even a legal minimum of £5.73/hour.

Of course it doesn’t work that way, it actually works the opposite way.  The longer I spent at the PC (buying a ‘reversal’ just as the rest of the market sold into the strength, jumping on the trend just as it reached a solid resistance level…) the more money I lost.  If you have a negative expectancy then the more trades you make the more money you lose.

Skip forward a couple of years and I have a positive expectancy. The logic goes that the more time I spend at the PC the more money I should make.  But now I am not even sure if that is true.

It is very difficult to be a break-even trader. The line between profitability and hemorrhaging cash is narrow and has steep sides. It only take a slight drop in performance to slip over the crumbly cliff-edge  and to start losing money again.

Meanwhile the algorithms traded without so much as a coffee break.

Because I am obsessive about recording every detail of every trade it was fairly easy to analyse my profitability against the time of day and week.  There was a slight signal that it takes me a while each new day, and new week,  to start to trade well (or perhaps it really is true that winners trade the close and only losers trade the open?). There was though a much stronger signal that trading for too many hours a day is detrimental to the account balance and so is trading too many long days in a row.

So now I take half a day off midweek, finish early on a Friday and probably earn just as much/little money. The only downside seems to be the abuse you get from ’9 to 5′ friends when you try and justify your work-shy attitude in the way I have just done here. Perhaps I am just a wimp and you are made of stronger stuff, but there are worst experiments to try than going to the cinema, pub, gym, massage parlour, mountains or beach on a string of Wednesday afternoons.

One of the great things about starting a new blog is that you know hardly anyone will be reading it. So it is safe to write about one of those ’3AM thoughts’ that would never otherwise see the light of day…

In a previous life I was a scientist and spent many a long hour trying to understand Fourier Transforms (well how else can you pass those dark evenings when you never get invited to parties?!).  Basically they are a way of transforming data from the time domain (the x-axis has times along it) to the frequency domain (the x-axis has… yep, you’ve got it). So the Fourier transform of a wiggly sine wave is a nice, clean spike (because it contains only one frequency).

At first this new way of looking at data is extremely difficult to ‘get your head around’, our world changes in time so our brains are wired to think in that same way.  So what has this got to do with trading? Well, I have started to notice that I often think of price not in terms of the time domain but in terms of the probability domain.

Just like with Fourier transforms this takes some practice but it seems to be a useful ‘new angle’. But as an example… That is no longer an area of strong support, that is an area where the probability of the price going lower decreases rapidly.

And how do you trade successfully in this probability domain? Look for areas of price where the expectancy of profit (probability multiplied by price change) is much greater than the expectancy of the loss. Which is what you are already doing, I’ve just made it more complicated than it probably needs to be.

One advantage though of thinking in this way is  that it helps to enforce the idea that a losing trade isn’t always a wrong trade (unless you also failed to correctly apply your strategy).  All you can ever do is get the probabilities on your side, you can’t ever know what will actually happen. To use a poker analogy, it is almost always right to call with a set of kings because a very high percentage of the time you will win.  But not always (and they are the ones you remember!).

Like I said, nobody is reading this yet so I am safe to come up with this nonsense.

My previous blog ‘Uncertain Futures’ was washed away in the flood, and I am being only slightly metaphorical with that statement. So I’ve moved in here.

New readers can expect amazing insight into the world of trading. Old readers know better and can expect the same kind of uninformed, poorly expressed, contentious content as before.

I am still trading index futures (mostly the FTSE) and dabbling in FX; paying the mortgage with one and part of the  broker’s mortgage with the other.  A bit of largely random background…

• I am based in a rural corner of the UK (where people marry their cousins).
• I have a healthy distrust of indicators, slightly less so of the people that use them.
• I have no interest in gaining untold riches (but need to feed and clothe myself), I just want to win at one of the greatest brain-games there is.
• There is no ‘Holy Grail’, this is the hardest way to make an easy living, and hard work is the only way to consistently make money.
• I believe in logic. Your gut feel counts for very little, mine for even less.
• I trade intraday and apply the same time-frame to my interest in politics/economics/etc.

So if that hasn’t put you off, let the fun commence, a post a week seems like a nice frequency to aim for…